UK: Flexible Pensions

Are the changes radical enough to get entrepreneurs saving again?
Last Updated: 28 November 2014
Article by Luke Brooks

With effect from April next year, pension savers will no longer be obliged to use their funds to provide an income for life. Luke Brooks examines the new rules.

The Government currently encourages individuals to make pension savings through a number of measures, most notably the ability to claim income tax relief on personal contributions and corporation tax relief on company contributions. Other advantages include an exemption from tax on income and capital gains generated within the fund, tax-free benefits on death before retirement, and a 25% tax-free lump sum on retirement.

The flexibility for pension funds to borrow up to 50% of their assets to acquire a commercial property that could be leased to an entrepreneur's business, and the ability, in certain circumstances, to invest in private company shares also have obvious attractions.

Despite these apparent advantages, many entrepreneurs have been wary of making significant pension provision due to the restrictions placed on the timing and the structure of the eventual benefits permitted by the registered pension regime.

Minimum age increases

It is well-documented that many early-stage entrepreneurial projects fail due to cash flow problems. For a younger entrepreneur the downside of investing in a pension over other vehicles, such as an ISA, is that no access is permitted to funds before the minimum pension age.

The minimum age for private pensions is currently 55 and will be increased to permanently sit ten years below the state pension age. Therefore, when the state pension age rises to 67 in 2028, the earliest possible access to a private pension will be at age 57.

While the uncertainty surrounding the timing of retirement benefits may dampen the enthusiasm of younger entrepreneurs, any historical concerns about the structure of the eventual pension benefits will be eradicated with effect from April 2015 and should act as a significant boost to entrepreneurial savers who already have the minimum pension age in sight.

Access to pension funds

For decades, private pension savers have been obliged to secure a 'lifetime annuity', a guaranteed income backed by an insurance company, by age 75 at the latest. The disgruntlement with this requirement grew as annuity rates dropped significantly from their peak in the early 1990s due, primarily, to reducing gilt yields and improving longevity.

Although 'income drawdown', with its income, investment and death benefit flexibility compared to an annuity, was introduced in 1995, the requirement to annuitise by age 75 remained until the 'pensions simplification' rules were introduced in April 2006. For the first time pension savers could avoid an annuity purchase through a restricted form of income drawdown, known as Alternatively Secured Pension (ASP). The ASP rules were relaxed in subsequent Budgets until, in April 2011, 'flexible drawdown' was introduced.

The flexible drawdown rules, which introduced the ability for pension savers to liquidate their private pension funds subject to income tax at their marginal rate, were initially only made available to those with guaranteed income of at least £20,000 (now £12,000) from other pension sources. Arguably, it was of more benefit to those with large final salary entitlements accrued from long periods of employment, rather than the entrepreneurial community.

Flexible rules set to attract entrepreneurs

The Chancellor's stunning announcements in this March's Budget mean that, with effect from April 2015, all pension savers will have complete access to their pension funds irrespective of how large or small their fund is. This significant relaxation of the rules applicable 'at retirement' combined with the traditional benefits associated with pension savings should encourage entrepreneurs, and other savers, to take a second look at the registered pension regime.

Auto-enrolment and pension protection – don't get caught out

Pensions auto-enrolment will continue to be rolled out to all UK employers – and their staff (called 'eligible jobholders') – over the course of the next few years.

The definition of eligible jobholders captures directors (and other senior staff), who have a contract of employment with the company. Employers are required to automatically enrol all eligible jobholders into a workplace pension scheme. Once enrolled, eligible jobholders can then choose to opt-out within one month if they do not wish any contributions to be paid on their behalf.

Anyone who has a Fixed Protection 2014 (or any previous form of Lifetime Allowance Protection) certificate or is considering Individual Protection must be aware that they are extremely vulnerable to such protection being breached as a result of their employer complying with auto-enrolment duties. In particular, pension savers who fail to 'opt out' in time will automatically lose their enhanced or fixed protection!

We have taken great care to ensure the accuracy of this newsletter. However, the newsletter is written in general terms and you are strongly recommended to seek specific advice before taking any action based on the information it contains. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. © Smith & Williamson Holdings Limited 2014. code 14/1018 exp: 31/03/15

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