The new tax year marks a new era for pension saving in which the keynote is flexibility.
With effect from 6 April 2011, the obligation to crystallise pension savings in the form either of an annuity or a restricted type of pension drawdown called Alternatively Secured Pension (‘ASP’) has been removed. Now, pension plans can be kept in place indefinitely and regarded both as a source of income and as a means of passing funds to family members.
The age 75 crystallisation requirement had become a real problem. People reaching this age were understandably reluctant to purchase annuities when rates have been relatively unattractive; while ASP permitted only limited income withdrawals and subjected funds to tax hits totalling up to 82% in the event of death.
"Now, annuities can be purchased at any age and there are two alternatives. First, all retirees aged 55 or over can opt for income drawdown – i.e. leaving their pension plan in place and drawing an income from the investments roughly equivalent to that which would be available from an annuity. Retirees reaching the age of 75 can continue with this ‘capped’ form of drawdown.
Alternatively, if post age 55 an individual can demonstrate that their various sources of pension income can be guaranteed to be at least £20,000 p.a. (the ‘Minimum Income Requirement, or ‘MIR’), they can opt for ‘flexible’ drawdown, which permits unlimited withdrawals to be made at any time, subject to income tax at the investor’s marginal rate.
The £20,000 guaranteed income required to qualify for flexible drawdown is most likely to be provided by State or occupational pension or annuity income.
Once flexible drawdown has been selected, no further tax relief on contributions will be available; and tax relief will in any event cease to be available at age 75. Consequently, flexible drawdown is most likely to be used by those aged 65 or over who have stopped work and are able to set their State pensions against the MIR.
Pension funds from which an income is being drawn will be subject to a 55% tax charge on death, but there will continue to be no tax charge on pension plans from which no income is being drawn; though this exemption will cease at age 75, when the 55% tax charge on death will apply to all plans, whether in drawdown or not.
The 55% tax rate on death compares very favourably with the alternative of drawing funds subject to income tax at up to 50% and then exposing them to a potential 40% charge to inheritance tax on death. Maintaining funds in a drawdown account, where they will also benefit from tax-free investment growth, has therefore become a viable means of estate planning.
However, the fact that plans which are not in drawdown will escape the 55% tax charge until the planholder reaches the age of 75 is likely to lead to the increased use by those under 75 of phased retirement, whereby segments of a pension plan are crystallised successively to provide an income, without the need to place the fund as a whole in drawdown.
As a result of these changes, pensions have become the par excellence tool for inter-generational tax and investment planning. Portfolios need no longer be targetted at arbitrary retirement dates but can address the reality that continued increases in lifespans demand that a more flexible view should be taken of the accumulation and decumulation of assets and the tax implications of alternative strategies.