Reduced £10k allowance
Accessing April’s new pension flexibility comes at a price – that future pension funding to money purchase schemes will be capped at £10k. It may seem a small price to pay for unrestricted access to a lifetime’s pension savings. Delve a little deeper and it becomes clear that with careful planning it needn’t be an issue at all.
It’s worth emphasising that this reduced allowance only applies to money purchase contributions. Anyone who is also accruing benefits under a defined benefit scheme will continue to have an overall annual allowance of £40k.
For many individuals, the first time they dip into their pensions will be the day they stop work. They have ‘retired’, and now want to spend their savings, rather than continue to build them up. And once they’ve stopped making contributions, a drop in the annual allowance is of no significance.
For this group, the emphasis will instead be on making sure they have enough saved before they retire. And the best time for this may well be in the years leading up to retirement. During this period their earned income is likely to be at a peak, and there may be scope to pay more than the £40k annual allowance by carrying forward unused allowance from earlier years.
And this opportunity doesn’t need to be funded from income. While earned income is necessary for individual tax relief, the funds can come from other savings without being deprived of access. This is because the new pension rules will give the over 55s unrestricted access to their pension savings. Consequently, it may be time to consider moving other non-pension savings into their pension where they will benefit from tax relief on contributions, tax free investment returns and tax efficient wealth transfer options.
Changing retirement trends
Stopping work completely is not for everyone. There’s a growing trend of people working beyond their normal retirement age, but who may still want to access their pension. Many of these will be well paid professionals who don’t want to give up work, choosing instead to carry on in a reduced capacity, or continue in a consultancy role.
Someone in semi-retirement may need their pension to supplement their reduced income. Anyone having a career change late in the day, or setting up on their own, may need a capital injection to get their new business up and running. And with access from age 55, their pension could support this.
But what if their new venture takes off and they wish to resume funding to replace the income or capital they’ve withdrawn?
Keeping your options open
The money purchase annual allowance will only be cut to £10k when flexible income is taken for the first time after 5 April 2015. So how an individual accesses their pension could be critical if they wish to retain the full £40k annual allowance for funding money purchase schemes.
Drawing the tax free cash only out of the pension doesn’t trigger the reduced annual allowance. This could be either as a single lump sum or taken as regular withdrawals to supplement income. Of course, this won’t be possible if their scheme only offers Uncrystallised Funds Pension Lump Sum (UFPLS) as the income element of each payment will always lead to a cut in the allowance.
Anyone who was already in capped drawdown before 6 April 2015 and doesn’t exceed their ‘capped’ income limit will also retain a £40k allowance for money purchase schemes. So those individuals over 55 who may need both tax free cash and income in the future may want to keep their options open by going into capped drawdown before April.
If the pension scheme is structured as a single arrangement, rather than a series of individual segments, this could be as a simple as designating just £1 for drawdown now. No income needs to be taken but it opens up the possibility of taking both income (within the cap) and tax free cash in the future without restricting their funding options.
The reduced allowance
The £10k money purchase annual allowance is only triggered at the point of accessing the new flexibility. Taking a secured income such as an annuity or Defined Benefit (DB) pension won’t see a reduction in the allowance. But anyone accessing drawdown for the first time after April will have their allowance cut. As will anyone already in capped drawdown if they exceed their income cap.
At the point the money purchase annual allowance is cut to £10k, any unused carry forward allowance will also be lost for future money purchase contributions. Those intending to use this allowance must therefore ensure the funding takes place before any flexible income is taken.
In the year the cap is triggered it may be possible to pay more than £10k. The allowance cut starts at the point flexible income is first taken, but contributions already paid remain subject to the £40k annual allowance.
So someone accessing flexible income may still be able to pay a further £10k after triggering an allowance cut, providing the total contributions don’t exceed the full £40k allowance. It effectively works in similar way to the 2011/12 ‘straddling PIP rules’.
For example, Christine designates her SIPP for flexi-access drawdown and takes an income payment on 1 December 2015. The input period for the SIPP is aligned to the tax year and before accessing drawdown she paid a single premium of £25k.
Christine’s money purchase annual allowance will commence from 2 December 2015. But she will still be able to pay a further £10k before 6 April 2016 as the combined amount won’t exceed the £40k annual allowance.
Planning to retire?
The new pension freedoms will make for a very flexible retirement. But individuals considering accessing the new flexibility may want give one last thought about maximising their funding before doing so. And if they want to keep their funding options open, they may want to think about designating some funds for capped drawdown before 6 April 2015 while the option is still open to them.
Source: Standard Life