++ STOP PRESS! ++ CHANGES TO RETIREMENT RULES

On 9th December 2010, the Treasury published its draft Finance Act legislation.  The rules will revolutionise the way pension benefits are taken, making retirement more flexible.

This information outlines the key changes. The rules are expected to take effect from April 2011. This summary is based on our interpretation of the December 2010 draft legislation and treasury guidance and is subject to change - in particular it is subject to actual legislation being laid.

This is a summary of the proposed new pension rules:

• New rules at age 77
• Compulsory annuity purchase abolished
• Alternatively secured pension scrapped
• Retirees can use drawdown indefinitely
• New flexible drawdown with unlimited withdrawals

So what is changing?

1.  There will no longer be a requirement to take pension benefits by age 77 - a rule that dates from 34 years ago. Whilst the majority of retirees will still want a secure income at the point of retirement, this change provides an alternative option for investors who would prefer to have greater control and flexibility over how and when their pension income is paid. The rules are positive news for pensions and make pension saving much more attractive.

What this means for investors

 It will be possible to leave your pension fund untouched for as long as you like. If you still have enough income from employment or other savings your pension can continue to grow free of UK income and capital gains tax. When you are ready you can still take up to 25% as tax free cash and use the remainder to provide a taxable income using an annuity or income drawdown.

However it is worth bearing in mind that the death benefits change once you reach age 77 if you have not taken benefits at this point.

2.  Retirees can use income drawdown indefinitely. Investors will be able to use income drawdown or take no income at all from their pension for as long as they want. However, tax charges on any lump sum death payments will prevent this option being used to avoid inheritance tax.

ASP, which had a number of restrictions and limited death benefits, will be scrapped.

What this means for investors

If at age 77 you decide to remain in drawdown you can still benefit from the same income rules and death benefits as pre 77. It will also now be possible to defer drawing any income until after age 77.

3   Flexible drawdown introduced.  This is a new drawdown option which will allow some investors to take as much income as they want from their fund in retirement. It will be available to people over the age of 55 who can prove they already have a secure pension income of £20,000 a year when they first go into flexible drawdown. The secure income can be made up of state pension or from a pension scheme and does not need to be inflation proofed. 

Investment income does not count. It will not be possible to make any further pension contributions to any pension scheme either in the year you move into flexible drawdown or any year thereafter.

What this means for investors

For those with sufficient income from other pension schemes, flexible drawdown will allow you to draw as much of your pension as you need, when you need it (subject to income tax). It will also be possible to use part of your pension to buy an annuity to secure the £20,000 and then move the rest of your pension to flexible drawdown .

4.   Current drawdown (now to be known as capped drawdown). The maximum income will be broadly equivalent to the income available from a single life, level annuity. This will be a slight reduction on the current maximum income allowed. There will be no minimum income, even after age 77.  The maximum amount will be reviewed every 3 years rather than every 5 years.  Reviews that take place after age 77 will be carried out annually. Unlike the current ASP, the income available after age 77 will be based on your actual age rather than defaulting to age 77.

What this means for investors

Capped drawdown is very similar to the current drawdown system. The main changes will be that the maximum income available under age 77 will be a little lower than at present and the maximum income over age 77 will be a little higher. There will no longer be a requirement to take an income after age 77. Under ASP it is always assumed you are 77 when calculating your income limits. Under capped drawdown your actual age will be used, meaning the percentage of your pension that can be drawn should increase as you get older, rather than remaining static.

5.  Changes to death benefits and tax charges. If you die whilst your pension fund is in either form of drawdown, or after the age of 77, all your remaining fund can be used to provide a taxable income for a spouse or dependant. Alternatively it can be passed on to a beneficiary of your choice as a lump sum, subject to a 55% tax charge (or nil charge if paid to a charity).  No tax is welcomed with open arms, but a 55% tax charge is a vast improvement on previous tax charges of up to 82% on lump sums paid after age 77.

What this means for investors

For investors in drawdown before age 77, the tax charge is now higher if you want to pass your remaining fund as a lump sum in the event of your death, however this is more than balanced out by the fact the tax charge is significantly reduced for passing your fund on after age 77. It is also important to note that the 55% tax charge will be applied on death after age 77 even if you have not purchased an annuity or moved into drawdown.

Rules for those already in drawdown

Individuals who are already in drawdown will not be immediately subject to the new requirements however transitional rules will apply. They will need to adopt the new rules either at their next review or when they transfer to another drawdown plan.  Investors already in drawdown can benefit from the new rules and can continue in drawdown past age 77. However it is likely that when the new rules are adapted at their next review, they will see a reduction in the maximum income they can take.

Tax free cash

The ability for most people to take up to a quarter of the pension fund as tax free cash will still be available when the individual sets up an annuity or goes into income drawdown, even if they take no income.  What this means for investors: There had been fears that the government may reduce or remove the ability to take a quarter of your pension tax free. Fortunately there has actually been little change to the tax free lump sum, with the exception that you can now take it after age 77 if you so choose.

Annuities

Annuities themselves will not change, however it will be possible to buy an annuity at any age after 55. An annuity will still be the option of choice for many retiring investors because unlike drawdown it provides a secure income for life. Annuities are expected to be used to secure the minimum income requirement of £20,000 to allow investors to then use the rest of their pension to go into flexible drawdown.  What this means for investors: Income drawdown can offer greater flexibility but it is higher risk because your pension remains invested. Annuities will continue to offer a secure income for most investors but there is the added flexibility of now being able to wait until after 77 to buy one if you so wish.