UK: What The Budget 2014 Means For Pensions

Last Updated: 25 March 2014
Article by Mark Howard, Judith Donnelly and Paul Hodges

Trustees and employers will need to think carefully about how the far-reaching changes in yesterday's budget affect their pension scheme. Scheme rules may need amending and investment strategies may need to change – particularly lifestyle funds. Some changes come into effect next week, with the more radical changes being introduced with effect from April 2015.

Budget 2014

The Chancellor yesterday announced far-reaching changes to the pensions regime:

  • From April 2015 members of defined contribution schemes will no longer be required to purchase an annuity on retirement
  • From April 2015 members of defined contribution schemes will be entitled to free financial advice on retirement from April 2015
  • From 27 March 2014, the rules on trivial commutation and income drawdown are being relaxed

Other changes affecting pensions included:

  • The minimum retirement age will increase from 55 to 57 in 2028
  • The State pension will not be included in the new cap on welfare spending
  • Individual protection is to be introduced from 6 April 2014
  • HMRC will be given broader powers to prevent pensions liberation
  • The Government will consult on options to simplify dependants' pension scheme rules

Removal of requirement to purchase an annuity

The most radical of the Chancellor's reforms is without doubt the removal of the requirement to purchase an annuity. From April 2015, members of defined contribution schemes will be allowed to take their pension as cash with amounts over 25% of the total pension pot being taxed at the marginal rate. Currently, members are taxed at a punitive rate of 55% if they take more than 25% of their pension pot as cash.

The Chancellor pointed out that annuity rates have fallen by a half over the last fifteen years. He rejected the 'patronising' view that people were not able to decide for themselves how to spend their own money: 'People who have worked hard and saved hard all their lives, and done the right thing, should be trusted with their own finances.'

The detail is yet to be announced. Unless the Government introduces overriding legislation, most defined contribution schemes will need to amend their scheme rules in order to enable members to take advantage of the new flexibility. Employers and trustees will need to carefully consider their options before making a decision and communicating to members.

Some employers and trustees may wish to take a paternalistic approach and require some part of the pension to be used to purchase an annuity. On the other hand, purchasing an annuity may not be the right option for all members, especially those who have small pension pots or other sources of income in retirement. The implications for the administration of the scheme should also be considered.

Employers and trustees will need to review the investment options in their defined contribution schemes, in particular the default fund. Lifestyle funds and target date funds which assume that members will purchase an annuity on retirement may no longer be appropriate default funds.

The stock markets reacted quickly to the announcement, with evident panic selling of shares in annuity providers. Some share prices were down by over 50% within hours of the budget. In the long term, we expect that many people will still choose to purchase an annuity to provide long-term security in retirement. However, the annuity market may need to become more competitive to attract new business.

Changes effective next week

Of more immediate concern to trustees and employers will be the reforms which come into effect next week. The rules relating to trivial commutation and income drawdown are being relaxed:

  • The trivial commutation lump sum limit for an individual's total pension savings will be increased from GBP 18,000 to GBP 30,000
  • The maximum size of a small pension pot which can be commuted for a lump sum will be increased from GBP 2,000 to GBP 10,000 and the number of pots that can be taken will be increased from two to three
  • The minimum income threshold for flexible drawdown will reduce from GBP 20,000 to GBP 12,000
  • The maximum GAD limits for those in capped drawdown will increase from 120% to 150%

Again, many schemes will require rule amendments to be made in order for members to take advantage of this additional flexibility.

Additional changes

Minimum pension age

The minimum age at which a member can take their defined contribution pension will be increased from 55 to 57 from 2028. It is unclear whether any protection will be put in place for pension accrued to date, where the member has an absolute right under the scheme rules to take that pension at age 55 (or age 50, if the pension pre-dates the 2006 reforms).

Individual protection

From 6 April 2014, the lifetime allowance for tax relief will be reduced to GBP 1.25 million: if a member's pension pot is greater than this amount, tax penalties will apply.

A new form of protection called Individual Protection 2014 is being introduced to protect those who have already built up pension pots of between GBP 1.25 million and GBP 1.5 million in the expectation that they would benefit from tax relief on the full amount. Individual Protection will work in a similar way to the protections put in place when the lifetime allowance was introduced.

Pensions liberation

The Government will legislate to give HMRC greater powers to prevent pensions liberation, with greater control over the registration and de-registration of schemes.

Pensions liberation occurs where a member takes a cash transfer value of their pension, but the cash is transferred into a scheme which illegally then returns a proportion of that cash to the member. The amount of cash returned to the member is usually much less than the actual value of the member's pension, with the pensions liberator taking the rest. The member also becomes liable to a 55% tax charge, something that they may not have been aware of when they agreed to the transfer.

The Government has linked pensions liberation with other forms of serious fraud and organised crime and has stated that tackling this practice is a priority.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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