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A Guide To Recent Changes In UK Pensions

The 2016 Pension Changes

1. Auto Enrolment

Pension coins people

In a nutshell, if you employ people, you need to give them a pension scheme.

The government wants to ensure that everyone has sufficient money to look after themselves in their old age. The way they have decided to go about this is by auto enrolling everyone into a pension scheme. This means that, when you retire, you will get both the State Pension (that you contribute towards through National Insurance contributions) and your pension pot that you now contribute towards automatically.

1.1. Staging Date

The staging date is when your business needs to have automatically enrolled your staff into a pension scheme. You may have received a letter from The Pensions Regulator, explaining when your staging date is. However, if you haven't received a letter, or if you have lost it, use our planning tool to find out exactly what you need to do and when to do it by.

Follow this link to see which penalties you may face if you don't comply.

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2. Annuities

2.1. Problems

The main problem is that annuities no longer offer the reasonable returns that they used to. Nowadays, if you invest £100,000 of your pension pot, you could get a £3,200 annual return until you die.

This level of income may not afford you much spending flexibility when you retire.

We shall go into the slightly more flexible option shortly.

Another important thing to consider if you decide to go down the annuity route is to ensure that the return you receive escalates to take inflation into account. The difficulty then becomes relying on predictions of future inflation rates which, if predicted wrongly, may leave you out of pocket.

Additionally, if all of your pension has been spent on an annuity you will no longer have a pension pot and, therefore, nothing to pass on to your loved-ones.

This consideration is even more significant following the recent pension changes. From 2015, money that you leave in your pension pot and don't spend on an annuity will be available to your beneficiaries tax-free, if you die before the age of 75. If you die after the age of 75, your beneficiaries will have a choice. The first option is to take the money as a lump sum, in which case the money will be subject to a 45% rate of tax. However from 2016, this option will move to be taxable at the marginal income tax rate. The alternative is for the beneficiaries to take their inheritance as regular income, in which case the money would also be subject to income tax.

2.2. Pros Of Annuities

You do not have to put all of your pension pot into an annuity. One of the benefits of the new pension laws is that you can take 25% of your pension pot tax free. You could take out the 25% and invest it in an ISA and then use the rest of the pension pot to buy an annuity.

This achieves three things:

  • Firstly, it gives you some money with which to treat yourself after you retire.
  • Secondly, it gives you the option to leave some money to your loved-ones.
  • Thirdly, you can use the rest of the pot to buy an annuity and secure yourself an income for the rest of your life.

This last point is particularly important. You can guarantee yourself an income and, therefore, do not need to worry about money and can relax and enjoy your retirement.

There are different types of annuities some of which are better than others. For example, certain annuities have a guarantee where, should you die a few years after the purchase of the annuity, your annuity income will be paid to a person nominated by you for a certain period. However, realistically, you can expect to pay more for these types of annuities and the returns could be even more modest than the example given above.

3. What Other Options Have The Reforms Made Available?

If you want to withdraw all your pension pot and spend it how you wish, this option is now available through income drawdown.

3.1. Income Drawdown: Changes From The 2014 Budget

Currently, the first option is the capped drawdown; this is where your pension pot is invested in stock and shares. This means that the rest of your pension pot will hopefully grow and ward off the effects of inflation. This type of drawdown will restrict the amount you can withdraw each month. This level of restriction is implemented by the Government Actuary Department, and is based on 150% of the income you would have received from an annuity if you had bought one. So this type of drawdown is perfect for those who like the stability of a regulated stream of cash. However, the problem with this option is that, as we have established, the income people now generally receive from an annuity is quite low. So 150% of an annuity is of limited value.

The other alternative is to withdraw whatever you like every month, for which there is the flexi-access drawdown (FAD). With this type of drawdown, if you do see a big spend on the horizon, then you can withdraw more that month. However, in order to take advantage of this, you will need to be enjoying additional income of at least £12,000 per year outside of the flexi-access drawdown.

If you choose to go down the FAD route, then you could be paying a much lower rate of income tax, obviously depending on the amount of money you choose to withdraw each month.

3.2. The New Rules From April 2015

From April 2015, there will be no capped drawdown option; this means that the flexi-drawdown will become available to everyone. It would be advisable to consider what income you realistically need to live and to provide occasional luxuries. As mentioned earlier, it is also important to remember that the money that you withdraw from your pension pot will be subject to income tax. So, if you withdraw a lot of money, you may be subject to the highest band of income tax and lose a lot of your hard-earned money before you can enjoy it. The government has given retirees a great deal of freedom to make their own decisions and it is important that people take advantage of this and plan properly.

In addition to planning how to manage your finances during your retirement, it is equally important to prepare for and take advantage of this pension flexibility in good time. If you can do as you wish with your pension, investing more money into your pension earlier in your life might be the best solution. In the past, someone might have a pension and then have a separate fund for treats like holidays during retirement. However, if you have complete flexibility, placing everything into your pension pot might be a more efficient and simpler way of preparing for retirement.

4. Pensions And Tax

As mentioned above, from 5 April 2015 when you withdraw your pension 25% of the withdrawal sum will be free of tax.

The graphic below will provide more information on pension withdrawals and income tax, and the things on which you could spend your pension withdrawal income!

Income tax

5. If You Have a Smaller Pension Pot, What Are Your Options?

As with the rest of the pension reforms discussed so far, the result of the latest reforms will be that you will get more freedom.

Before the 2014 budget changes, if your pension savings were less than £18,000 you could take the full amount at one time. However, if you had over £18,000 worth of pension savings, you could draw it as single cash payments of less than £2,000.

Mature couple beach

After the 2014 budget report, the amount you could take out as single cash payments increased to £10,000 and, if your total pension pot was smaller than £30,000, you could withdraw the entire amount at one time.

After the recent changes (which come into effect on 5th April 2015), you will be able to withdraw as much as you want, regardless of how large or small your pension pot.

In terms of tax, it is also worth remembering that if you have a smaller pension pot, the income tax bracket that your pot falls under might be lower. However this is worth checking.

6. Changes To The State Pension

In addition to the money that you have contributed to your private pension pot, you will also receive the State Pension. For those who are retiring, or have already retired, during the 14/15 tax year, this will be £113.10 every week, provided National Insurance contributions have been paid for 30 years or more. If you have not been contributing for this length of time then your State Pension will be proportionally lower.

6.1. State Pension Booster

You can also save towards an additional State Pension. The maximum this additional State Pension would grant you is an extra £167.40 every week. However, you need to have saved into this type of scheme for a number of years and you may have contracted out of the scheme through your employer. Unfortunately, from 2016, additional State Pensions will no longer be available.

6.2. The New State Pension

The new State Pension will see the end of additional contributions. The graphic below will provide more detail on the other changes that the new State Pension will bring.

New state pension

If you have already started contributing to the old additional State Pension scheme through National Insurance contributions, what will happen under the new scheme? Law-makers have thought of that and have come up with this solution.

From 2016 the Department for Work and Pensions will work out:

  • Your additional entitlement from the old State Pension scheme, following your historic additional contributions into that scheme.
  • Your contributions into the new State Pension scheme post 2016.

The DWP will then work out which is higher, and this will become your foundation amount. If your foundation amount is higher than £152 per week (the new State Pension amount), then you will receive your foundation amount, otherwise you will get the new amount. This will ensure that no-one misses out on pension that they have fairly contributed towards.

However, what if you are a pensioner who has started drawing your State Pension before reading this? The bad news is that you will miss out on the new £152 a week State Pension.

Thankfully, there are ways to mitigate your losses. You will be able to supplement your current State Pension by a maximum of £25 per week by making a one-off National Insurance contribution. However, the size of this one-off NI contribution, and the return you get on it, will depend on your age. For full details have a look here, or, if you are really struggling, give the State Pension people a call on this number: 0845 600 4270. It is important that you take advantage of this deal quickly, as it is only available from October 2015 to April 2017. It is also important to assess whether you might get a better deal by using your one-off payment to buy an annuity instead.

6.3 How Old Do I Have To Be To Get My State Pension?

Currently, men need to reach the age of 65 to be able to withdraw their State Pension, and women need to reach the age of 62. In 2018 women's State Pension age will be equal to men's. And this is not the end of the story. By the year 2020, the pension age for both sexes will go up to 66. The year 2026 will see the pension age increase to 67 and during the 2030's the pension age will increase to 68.

7. What If State Pension Isn't Sufficient To Keep Me Going?

Pension credit may be the answer.

The current rules state that if your current pension pot plus State Pension allowance provides you with less than £145.50 per week, or as a couple you are provided with less than £222.05, then you might be eligible for pension credit. Pension credit is composed of guarantee credit and savings credit.

For details on eligibility criteria for guarantee credit follow this link Guarantee credit could boost your weekly pension income to a reasonable £145.50 (or £226.50 per week for couples).

The second part of pension credit is savings credit. But don't get too attached to this, as it is being removed as part of the recent pension reforms.

Savings Credit: Eligibility Criteria

  • Single Pensioners: Have an income of more than £120.35 per week.
  • Couples: Have an income of more than £192.00 per week.
  • Either you or your spouse must be older than 65.
  • Residence in the UK.
  • You need to have some sort of other pension pot.
  • What savings credit gives you:
Pen pounds calculator

Each time you contribute £1 into your pension pot, savings credit will contribute another 60p. In reality, you needed to know about this several years ago to really be taking full advantage of it. However there is still time. If you reach the pension age before 2016, and are eligible for savings credit, you can still take advantage of it.

8. Working Past Retirement Age

Savings Credit: Eligibility Criteria

  • Single Pensioners: Have an income of more than £120.35 per week.
  • Couples: Have an income of more than £192.00 per week.
  • Either you or your spouse must be older than 65.
  • Residence in the UK.

You need to have some sort of other pension pot.

What savings credit gives you:

Each time you contribute £1 into your pension pot, savings credit will contribute another 60p. In reality, you needed to know about this several years ago to really be taking full advantage of it. However there is still time. If you reach the pension age before 2016, and are eligible for savings credit, you can still take advantage of it.

9. If You Are Nowhere Near Retirement Age, What Options Do You Have To Increase Your Retirement Income?

9.1. Investing Your Retirement Income

The most popular options for this are:

  • Property, in the form of buying to let.
  • The stock market.

9.2. Defer The Date You Draw Your State Pension

At the moment, if you could afford to defer your pension by a year, the amount you could receive after that would increase by 10.4%! Or you could just take the year's pension allowance you saved up in one go (however there are restrictions on this option).

For information on deferring your State Pension follow this link.

However, State Pension deferral is set to change under the 2016 rules. See the graphic below for details.

Deferring payments

10. Following the 2016 Pension Reforms, What Can You Do With Your Pension At Each Age?

Pension timeline info

11. Conclusion

In conclusion, auto enrolment has featured at the head of a variety of important pension changes. The changes will see the UK pension system changed in a historic way. We hope this guide will have given you an outline of how the changes may affect you and your family.

To learn more about pensions, please visit our Knowledge Bank.

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