"Whilst the ability to unlock pension funds is attractive, clients and their advisers need to understand the tax implications of doing this and accept the risk of ensuring that the funds built up are managed effectively to ensure that they last for life, however long that may be."
Ahead of one of the biggest reforms to pensions in recent times, Angela Green, Chartered Financial Planner and Senior Manager Wealth Planning Team at Bank of Scotland, discusses the choices the reforms will provide and the impact on planning for retirement.
Perhaps the greatest benefit of the forthcoming pension reforms is the flexibility it offers in terms of being able to save tax efficiently. By liberalising access to the pension pot for savers over the age of 55 years for defined contribution (money purchase) plans, this type of pension fund can be considered as part of a wider investment planning strategy rather than just to generate funds in retirement. We should start to think about pensions differently – what a pension fund will offer is another effective tool to save tax efficiently even potentially over and above an ISA.
The changes mean that if you are in a position where you don’t need your pension funds, you can pass the fund onto your wider beneficiaries in the event of death rather than just your spouse/civil partner or financial dependant. Under current rules, if you die aged 75 years or more and leave unspent pension funds, these are subject to tax at 55% unless either a spouse, civil partner or dependent child receives an income from it. Under the new rules, any unused defined contribution pension may be passed on as a tax-free lump sum if you pass away under 75 years of age. And over the age of 75, it can be passed on as a lump sum taxed at 45%, or at the beneficiary’s normal rate of income tax if taken as income. This means that your pension can be a valuable asset when considering inter-generational wealth planning.
This is a radical change. Whilst pensions have always been a very tax efficient way of saving, many clients express concerns that money invested in that way will be tied up and locked away from either them or their beneficiaries. From 6 April 2015, that is no longer the case for those who have funds in money purchase (or defined contribution) pension plans.
In addition, the pension reforms will also enable those savers on defined benefit schemes to transfer their savings into a defined contribution scheme, as long as pension payments have not begun. Furthermore before any transfer can take place, the Government has specified, advice from a professional financial adviser must be sought.
There are exceptions, however. Members of unfunded defined benefit schemes will not, apart from in exceptional circumstances, be able to transfer their pensions. The reason behind this is because unfunded schemes, such as those for NHS employees, are funded purely by general taxation. This is in contrast to funded schemes, which have additional reserves and assets that help pay for the entitlements.
What has tended to hit the headlines around the new reform has been the ‘benefit’ of being able to access your funds. Whilst for some, repaying debts may necessitate that, individuals who are looking to remove pension funds to invest elsewhere should carefully consider the tax implications of such a move. If these funds are not needed to spend, it would be difficult to see what other investment plan could be as tax efficient. Not only that, there may be tax considerations when funds are taken out - for example, 75% of the emerging pension fund you draw will be taxed as if it was your income. Thinking about whether an alternative investment strategy is sufficiently attractive to offset the tax charge and loss of tax efficiency should be top of your agenda.
Providing pensions with the same degree of flexibility as other forms of investment can help clients plan for life beyond retirement. For many over-55s, retirement may be phased or a gradual wind down so are not looking to tie up their capital to secure an income immediately. The reforms allow access to money purchase pension funds to unlock capital required to spend without having to commit to the purchase of a new product. In this way clients can keep their options open until they want to commit to a longer term strategy, if that is what they want to do.
Whilst having the option to access funds for capital investment, the reforms come with an increased responsibility for individuals which is to ensure you have sufficient assets to support you in later life. Whilst the ability to unlock this capital is attractive, clients and their advisers need to understand the tax implications of doing this and accept the risk of ensuring that the funds built up are managed effectively to ensure that they last for life, however long that may be.
The reforms highlight the need to take advice and consider your overall position. Although it may seem counter-intuitive, accessing your pension fund in many cases may be the last asset you call on, given the tax efficiencies.
The views expressed are those of the individual featured as at November 2014 and are not intended to provide legal, tax or financial advice.
Past performance is not a reliable indicator of future performance. The value of investments and the income from them can fall as well as rise and cannot be guaranteed.
Tax treatment depends on individual circumstances and may be subject to change in the future.
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