Understanding the UK pensions revolution
Martin Upton is Director of the True Potential Centre for the Public Understanding of Finance (True Potential PUFin) at The Open University. Here, he discusses how his free online course, “Managing My Investments,” coincides with the start of a pensions revolution in the UK and offers some advice on what this revolution means for everyone.
“Managing My Investments” is a course that studies investments and pension planning. It coincides with the start of the liberalised era for pensions that has just kicked in at the start of the UK 2015/16 tax year. The course is a timely aid to those either planning for their pension or just simply looking at alternative investments for the short-, medium- and long-term.
Key features of the pensions revolution
These are the key features of the pensions revolution, introduced by the coalition government:
- Greater freedom for those in “defined contribution” schemes to access personal pension funds (or “pots”), to invest in a range of assets (like property), to produce pension income, to pay off a mortgage or other debts, or simply to finance current consumption. Up to 25% of pension pots can be accessed tax-free by those aged over 55 and there is no requirement to use pension funds to purchase an annuity. Sums accessed in excess of 25% are taxable as income and so could attract tax of up to 45% (for taxable income above £150,000) – so be careful and tax efficient in the choices you make.
- As an alternative to buying an annuity, many are expected to leave at least 75% of their pots invested and take income from the fund when needed.
- Those with defined contribution pension pots, who are not yet looking to draw on it for retirement, can use an arrangement called an “uncrystallised fund lump sum payment” (UFLSP). This enables smaller withdrawals to be made on as many occasions as you like. You can even withdraw the whole pot. With these withdrawals, 25% of each sum drawn out is tax free.
- A proposal for freedom, from April 2016, for five million existing defined contribution pensioners to sell their annuities for a lump sum, which can then be accessed in the same way as for those approaching retirement, as set out above.
- Greater flexibility to pass on a pension to dependants after death. For those dying up to the age of 75, the pension pot (or survivor income and lump sums from annuities) can be passed on free of any tax deductions. For those dying after 75, the tax rate applied will now be 45% instead of 55% (reducing to normal tax rates from April 2016) on lump sums and normal tax rates on income.
The risks from these new rules
There are risks arising from these new flexible rules, which you need to be aware of:
- There is the risk of making tax inefficient decisions with chunks of hard-earned pension pots being passed to HMRC rather than used and enjoyed in retirement.
- There is the risk of scams, with fraudsters offering, for example, to transfer pension pots into new unregulated investment schemes with high fees charged and in ways that expose pensioners to high tax bills. There is also the risk that fraudsters simply steal the money, for example, by offering to transfer pension pots into new schemes only for the new “fund” to turn out to be fictitious. So, hard earned pension money is gone, but the victims still have to pay the tax bill. Guidance on these risks is provided in the Pensions Advisory Service booklet Scamproof Your Savings.
- Some may simply spend their pension pots quickly and, as a result, have no non-state pension to live on. Despite media hype – with references to pensioners buying Lamborghinis – this is likely to apply to only a small percentage of people enjoying the new freedoms. Most people who have carefully planned for their pension over their working lives are unlikely to blow their pension pots thoughtlessly. Nevertheless, careful thought needs to go into how to spread the pension pots accrued over the expected life in retirement.
The importance of using these new pension freedoms with care cannot be overemphasised.
Where to get advice
Those approaching retirement should at the very least access the guidance given by the government’s new service Pension wise. This includes the ability to book a free guidance session – either by phone (call 0300 330 1001, 8am–10pm Monday to Sunday) or with the Citizens Advice Bureau.
Talking to an FCA-regulated financial adviser makes very good sense too, given the importance of the decisions being made and the risk of exposure to fraudsters. Details of such advisers can be found via unbiased.co.uk.
You can also find out more by joining the free online course, “Managing My Investments.” It begins on 11 May 2015.