From April 2016, five million UK pensioners with existing annuities will have the right to sell the income they receive from them, the Chancellor said in today’s Budget.
On top of that, George Osborne has cut the lifetime maximum allowance for tax-free pension savings from £1.25million to £1million, but this reform is likely to affect a far smaller group of people.
The changes announced today build on the Chancellor’s sweeping pension reforms made in the Budget last year and are intended to pave the way for an era of greater pension freedom.
Changing times: From April 2016, five million pensioners with existing annuities will be able to cash in their existing annuity
From April 2016, pensioners will be able to cash in their pension savings when they retire rather than buy an annuity. Pensioners with existing annuities will also be able to cash in their annuities and benefit from being able to access their pension money when and how they want.
The Chancellor said today: ‘For many an annuity is the right product, but for some it makes sense to access their annuity now. So we’re changing the law to make that possible.
‘From next year the punitive tax charge of at least 55 per cent will be abolished. Tax will be applied only at the marginal rate. And we’ll consult to ensure pensioners get the right guidance and advice’.
The Chancellor’s latest annuity reforms, worth more than £10billion, will give pensioners the same opportunity to access their retirement funds as the Chancellor announced last year for people who had not already taken out their pensions.
The removal of restrictions on buying and selling existing annuities will allow pensioners to sell the income they receive without unwinding the original contract. People will be free to either take the cash as a lump sum or place it into drawdown to use the proceeds more gradually.
Cuts: The Lifetime Allowance will be cut from £1.25million to £1million, the Chancellor announced today
In a recent interview, George Osborne told the BBC: ‘It’s all part of trusting people who have worked hard and saved hard all their lives. It’s all part of having a long-term economic plan where we build our country on savings and investment’.
Responding to claims that pensioners could end up spending their pensions recklessly on fast cars or holidays, Mr Osborne told the BBC: ‘I just think that is a very patronising attitude to take towards people who have shown responsibility, saved through their lives, saved for a pension’.
Responding to today’s Budget pension reforms, Nick Hungerford of Nutmeg said: ‘The Chancellor’s sweeping pension reforms continue at breath-taking pace. The announcement that pensioners will be able to trade in their annuities for cash is another exciting, bold move. It gives people even more flexibility and choice, giving them full control of their retirement income.
‘We stand 100 per cent behind these pension freedoms. However, people need support to help understand the new rules and decide what’s best for them. Traditional financial services companies have been slow to change, and for decades, UK pensions have been riddled with mind-boggling complexity and needless restrictions.
‘But these reforms are coming so fast, it could send many people into a tailspin and leave them open-prey to slow adaption by existing companies and dangerous new “too good to be true” promotions. It is up to the financial industry to help investors make informed decisions’.
In light of the extended freedoms for pensioners to buy and sell their annuities as they wish, the government is also launching a consultation on how a secondary annuities market would work in practice.
In response, the National Association for Pension Funds said: ‘This clearly fits with the Government’s agenda for pensions, but it’s unclear how savers will be protected. We welcome the full consultation as it will be essential to ensuring a fair and balanced market’.
Annuities provide a guaranteed yearly payout, usually for the rest of someone’s life. They therefore act as a guarantee that that person will not outlive their savings.
But the annuities market has come under increased scrutiny in recent years amid plunging rates and fears that many people are unaware that they could get a better deal by shopping around rather than sticking with their existing pension provider.
Lifetime Allowance cut to £1million – a dangerous cap on aspiration?
While citing the ‘gross cost of tax relief’ in the UK, the Chancellor announced that the Lifetime Allowance will be cut from £1.25million to £1million on April 6 2016.
The Lifetime Allowance relates to the maximum sums of money people can pay into their pension every year and during their entire lives and still qualify for tax relief.
Less than 4 per cent of pension savers currently approaching retirement will be affected and the cut will save £600million, the Chancellor said.
The Chancellor also confirmed that the Lifetime Allowance will be raised in line with the Consumer Prices Index when required.
Back in 2006, the Labour government introduced an annual cap of £215,000 and a lifetime cap of £1.4million. Since the current Coalition government came into power, the annual and lifetime caps have been reduced to £40,000 and £1.25million respectively.
At present, savers can roll over unused annual allowances up to a maximum of £120,000. To soften the blow of today’s proposals, savers will be permitted to roll over their unused annual allowances up to a maximum of £150,000.
Coalition cuts: George Osborne (pictured) said he investigated a plan to restrict the Annual Allowance for pensions and use the money to cut tuition fees. In today’s Budget, the Chancellor dismissed the proposal
Labour also planned to cut the Lifetime Allowance to £1million and use it for cutting costs on student tuition fees instead.
Having examined the proposal for restricting the Annual Allowance for pensions and using the money to cut tuition fees, the Chancellor said today: ‘It involves penalising moderately-paid, long-serving public servants, including police officers, teachers and nurses, and instead rewarding higher paid graduates.’
Critics have been quick to expose the potential drawbacks of today’s Lifetime Allowance reduction. Nigel Green of deVere Group said it was a ‘dangerous cap on aspiration’.
Mr Green said: ‘Another reduction in the lifetime allowance is scandalously counter-productive. This pre-election gimmick is a disincentive to save as much as possible for retirement and, therefore, it could be harmful to Britain’s long-term economic success.’
Steven Cameron of Aegon said: ‘How disappointing to see the government once again taking a short-term approach to pension tax by cutting the Lifetime Allowance from £1.25m to £1m from next year.
‘A £1m pension pot may seem huge, but with improvements in health and life expectancy, people who retire at 60 may need to use their pension income to cover their costs for 30 years or more. If you want your pension to continue to your partner and rise with inflation, £1m will buy you less than £30k a year. Many people aspire to more than that.
‘As people live longer, Government should be encouraging them to build up adequate savings for longer lives including paying for very expensive long-term care. Reducing the amount that can be saved in pensions is, in our view, a move in the wrong direction’.
Why the Lifetime Allowance is not just a headache for the rich
Reductions in the lifetime allowance over the years have meant it is now a consideration of many more workers than it once was.
Make no mistake, anyone hitting it will be firmly in the high-earner camp, whether under existing plans or Labour’s proposed lower limit.
However, it is fair to say it won’t be hedge fund managers and CEOs impacted in the years to come, it will be many thousands more earning healthy, but not astronomical, salaries.
For example, if someone starts their career earning £30,000 and is lucky enough to enjoy promotions and pay rises equivalent to 5 per cent a year on average over their career, they would be earning around £165,000 after 35 years of work.
If they were to contribute the recommended 15 per cent of their salary to a defined contribution pension throughout their career, and their fund grew at 7 per cent after fees, they would hit the current £1.25million lifetime allowance in their 34th year of work.
Under Labour’s proposed £1million limit, they would hit it in their 32nd year of work.
The allowance is hit sooner if they contribute more than 15 per cent, as many older workers do, or if their pay rises faster than 5 per cent a year or if their fund achieves better than 7 per cent growth.
That £165,000 salary and £1million pension pot sound like a lot of money, so many will think this is not their problem.
But it is vital to remember that you need to think of this not in terms of today’s money but in terms of what the sums will be worth in thirty-odd years time after inflation has eaten into their purchasing power.
If you earned a £30,000 salary today and rose in line with inflation of 3 per cent a year, in 34 years time you would earn £83,000.
Tom McPhail of Hargreaves Lansdown said another cut in the allowance will bring increasing numbers of middle earners into paying ‘punitive’ tax charges and add more complexity to the system.
Meanwhile, Jason Whyte of Ernst & Young commented: ‘The government has long been concerned with the proportion of pension tax relief that is claimed by higher rate taxpayers, and a further reduction in the lifetime limit is an obvious way to curb it.
‘However, it could clash with the reforms announced in the Autumn Statement allowing dependents to inherit pension wealth tax free, and after the election we may see something more radical such as a flat rate of tax relief for all pension savers’.
The NAPF said: ‘The Chancellor’s commitment to index-link the Lifetime Allowance from 2018 is welcome. But the question remains, what will the LTA be in three years’ time?
‘Let’s hope past performance is not an indication of future cuts. The LTA has been cut by £0.5m in the last three Budgets which if repeated would leave an LTA of £0.5m. This would buy an income of around £10,000 per year.’
Nick Hungerford of Nutmeg said: ‘The maximum lifetime allowance for tax-free pension savings has been cut once again to £1 million. Although it looks like the government is hitting pensioners with this lower lifetime allowance, this system discourages sensible, regular investing over a long time period.
‘It penalises good investors who have started early and regularly invested well over their lifetime, building up a big retirement pot. Instead it is skewed towards those who just want to stash a portion of their money away to shelter it from tax. Even with the promise of an indexed allowance from 2018, it would still take until 2029 to get back to the current allowance of £1.25 million assuming annual inflation of 2 per cent’.
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