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Missing the pension point?

In the run up to the changes to pension legislation, much of media (and political) coverage focused on costs and freedom. On the one hand, Ed Miliband seemingly couldn’t mention pensions without also using the term ‘rip off’ (TelegraphGuardianFTAdviser) whereas on the other, it would appear that Lamborghini (BBC) would be very busy come April….

5th April 2015 came and went and not a great deal changed for many – other than the small matter (for those interesting in facts rather than) that pensions suddenly became significantly more flexible and, potentially, even more tax effective.

Prior to April, pensions were primarily used to provide income in retirement; either a guaranteed income (an annuity) or an income which isn’t guaranteed but could potentially be paid at a higher level (drawdown).

Pensions, therefore, were all about providing an income stream and they essentially helped people defer income until a later date (and hopefully to a time where they pay less tax).

On death, funds in payment would either be taxed heavily (55% on lump sum death benefits in drawdown), potentially lost (if no death benefits were arranged on an annuity) or paid to a dependent. Dependent here being the key word – once benefits were drawn, the scope to pass on benefits became restricted and, potentially, subject to significant tax.

Moving on, we’re now in a new world….. two key things have changed.

Firstly, pensions do not have to provide income – funds can be withdrawn as the recipient sees fit and whilst the technicalities of this are outside the scope of these musings, the principle is that a quarter of those funds are tax free and the rest is taxable as income – irrespective of whether that ‘income’ is taken on the drip or as a lump sum.

At a stroke, this opened up control and flexibility…. and in turn, tax management opportunities.

Someone in semi retirement can top up their income using their private pension whilst they wait for the state pension date to arrive and if personal income tax allowances aren’t being fully used, funds can be withdrawn and whilst taxable, the proceeds would be tax free as far as they fall within the personal allowance (See here).

This also removed what could sometimes be seen as a hurdle to pension planning – the notion that you lose control of capital – whilst the fact remains that benefits can’t currently be accessed until 55 years of age at the earliest, thereafter access and control awaits the investor.

Secondly, there is much more control, choice and potentially tax effectiveness with regard to lump sum death benefits. For starters, if death occurs prior to 75 years of age all death benefits are now tax free – potentially saving the beneficiaries of those in drawdown a 55% tax charge on lump sum death benefits OR avoiding income tax where benefits are received on the drip.

Alongside that, it is now the case that income can be passed to non-dependents – anyone in fact – providing the provider permits it and you make the necessary arrangements to request it. What’s more, there is no tax charge on the transfer of assets to the beneficiary – giving them scope to ‘inherit’ the pension fund.

This therefore opens up the notion of ‘family pensions’ where funds could cascade between generations – something many may well see as a useful development.

Therefore rather than funds heading for the exits, our experience is quite the opposite – pensions are now even more tax effective than ever. Not only do payments attract Government tax relief, the funds still grow tax effectively and are generally are not liable to Inheritance Tax.

Once withdrawals are needed, a bit of planning can help to mitigate income tax as far as is possible – with funds now being withdrawn as and when needed.

As time moves on, there should be peace of mind that, when the time comes, the funds can pass on to other generations – providing the necessary steps are taken by the policy holder to arrange this – potentially giving the beneficiaries a head start to their own retirement planning.

The very nature of pensions has therefore changed and for many they may well need to look again at the opportunities they bring and whilst the treatment of their funds on death may be at the back of their thoughts, this may in fact need closest attention given that unless adequate steps are taken, the beneficiaries of the funds may find that they are unable to take advantage of the new rules.

Therefore rather than getting overly excited about sports cars or getting depressed about ‘rip off charges’, perhaps the message should be much more positive – financial planning has suddenly been blown wide open and, more than ever, people have the opportunity to live the retirement life they have perhaps always dreamed of.

Dobson Hodge No Comments

Marmite pensions and the importance of £14,133

Love them or hate them, pensions typically involve people having strong points of view whilst also being the subject of political interference.

Since 2001 we have had a raft of changes – the advent of stakeholder pension charge caps and the associated legislation on employers, the (now laughable!) pension simplification in 2006, changes to state pension provision (and timing), fluctuations in pension funding allowances, automatic enrolment obligations on employers and now the ‘pension freedoms’ which are due to commence in April 2015.

If anything keeps financial planners on their toes, it’s pensions – however those of you who are lucky enough not to need to keep up with the latest developments may well find that your views of pensions are clouded by misinformation, misunderstanding and – perhaps – a general detachment from reality.

There are key changes taking place in April and whilst there is too much to cover in a post like this (and if detail was provided, there is a danger of perceived advice!) there are some key (dare it be said ‘exciting’) developments taking shape.

Pensions have always offered a tax effective way to invest – giving people the ability to invest in assets which grow virtually free from tax, offering 25% of the fund ‘tax free’ whilst also deferring income tax (with the objective being that benefits are drawn in a lower tax environment that that when funds are invested). In summary, pensions typically offer a very tax efficient way of creating income in retirement.

The main ‘issue’ with pensions is that capital control is lost and whilst for those seeking to generate income in retirement this is not generally a concern, for others it can be a genuine objection.

From April 2015, however, this potential ‘barrier’ is removed once the age of 55 is reached given that access is permitted without restriction; however perhaps the greatest change is that pensions will be able to be passed on not only between spouses/dependents but also between non-dependent beneficiaries – therefore offering scope to cascade pension wealth between generations.

Pensions will therefore enable individuals to build up funds which will be paid free from tax in the event of death before 75 and if death occurs after 75, the tax charge on death on funds could be as low as 0% (currently, it stands at 55%).

Add to this the flexibility that individuals will be able to draw income or lump sums from their pensions as required – not only does a pension continue to offer the tax effectiveness it always has done, it opens up freedom of access once an individual reaches 55 and also offers a means to shelter assets from Inheritance Tax for longer!

For those who are looking to retire early and specifically have no other taxable income (i.e. they have not yet drawn their state pension) the new rules will provide the opportunity to potentially draw up to £14,133 (in tax year 2015/16) without any tax liability – £28,266 for a couple – with the expectation that this annual figure will increase in years to come.

Historically, therefore, pensions were used to provide income ‘on the drip’ – the new rules will permit investors much greater flexibility to generate tax effective income based on their personal circumstances.

Whilst ‘unknown unknowns’ can cause untold damage to financial wealth, it is also important not to overlook other potential opportunities that legislation change often brings – given all of the above and the number of misconceptions associated with pensions, it is therefore perhaps time everyone gave them another ‘look’!

Dobson Hodge No Comments

Apples, Apples and Pears

When considering a decision, it’s important that we compare ‘apples with apples’ in order to avoid comparing apples with pears.

In the past, ISAs and Pensions were quite different ‘tax wrappers’ and trying to compare them was indeed like comparing apples and pears.

Simplistically, an ISA is used to accumulate funds on which tax has previously been paid whereas pensions are used to defer income (and any resulting tax) until later.

Whilst ISAs could be used to provide both capital and income, pensions were most commonly used for creating a lifetime income in retirement. Add to that their very different tax positions and this results in an apparently simple question of ‘what is best an ISA or a Pension’ needing a very long answer – and ultimately the conclusion is often ‘you won’t know until you get there!’.

Things are about to change, however, and from April the benefits both ISAs and Pensions can provide are essentially the same – both will be able to provide income and both can be accessed for capital – and therefore they are now much more like each other.

However, it would appear that the media and other commentators have not picked up on this yet.

Let’s look at a possible ISA lifespan: whilst working someone funds it whilst they can afford to – perhaps taking some risk in order to hopefully achieve investment growth – and then perhaps once they retire, they reduce the risk and start to draw an income from it (perhaps with the odd lump sum to pay for a cruise or something similar!). How long that income will be paid will depend on his the fund grows and the income levels taken.

Now let’s consider pensions: under the new rules, whilst working someone funds it whilst they can afford to – perhaps taking some risk in order to hopefully achieve investment growth – and then perhaps once they retire, they reduce the risk and start to draw an income from it (perhaps with the odd lump sum to pay for a cruise or something similar!). How long that income will be paid will depend on his the fund grows and the income levels taken.

Spot the difference – nope – there isn’t any – and therefore whilst there is a tendency to worry about peoples pensions running out under the new rules, I’ve never read an article which discussed the risk of ISAs running out!

The key issue is that both ISAs and Pensions enable monies to be set aside for the future – ISAs are funded from taxed money, Pensions are funded from tax deferred monies (and therefore taxed on the output) – both equally carry the risk of running out.

If the big picture focussed on the importance of planning for income for the rest of someone’s life, they are more likely to become engaged with the strategies needed than if they read about the ‘risks’ and ‘dangers’ of their pensions running out. (….this article was written a little while back however an example of this ‘fear’ can be seen here –

Over the next few months the way individuals can plan and fund for their retirement will change dramatically given that the manner in which funds can be dawn will become much more flexible and, for many, potentially more tax effective –therefore the hope is that this will result in individuals taking a much closer look at their longer term needs and how they can fund them rather than worrying about doom, gloom and scare stories.

Let’s therefore hope that these changes engage people to plan for their retirement rather than give them even more to worry about!