Why your retirement just got better
New rules mean you can enjoy a little more flexibility when it comes to your pension.
The Government has unveiled some significant changes to the way our pensions will work in the future, by scrapping compulsory annuitisation. But will it benefit all of us, or just a select few?
How it used to work
In December the Government announced an end to compulsory annuitisation.
It used to be the case that once you reached the age of 75, you were obligated to buy an annuity – a financial product which pays you a regular income – though you could ‘annuitise’ earlier if you wished.
Critics of compulsory annuitisation didn’t like the fact that pensioners were essentially told how their pension funds had to be used, and argued that such rigidity actually put off many of us from putting money aside into our pensions. The dismal rates on offer from annuities, which have been steadily declining for some time now, didn’t help either.
However, since 2006 there has been something of an alternative to annuities – alternatively secured pensions. These work as a form of income drawdown, where your pension money stays invested, and you draw an annual income from the fund. This did allow a little flexibility, in that you didn’t have to commit all of your pension fund towards buying your annuity – you could instead mix and match, within certain limits.
The new regime
However, that’s all changed now.
From this April, you will no longer be compelled to annuitise your pension pot, though other changes are also being introduced to ensure that you don’t go crazy with your savings once you get your free bus pass.
If you wish to delay taking out an annuity and instead take an income from your pension – known as a drawdown – there will be two forms to consider, capped drawdown and flexible drawdown.
For most of us the capped drawdown system will apply.
This tip is absolutely vital to know if you want to make the most of your pension pot at retirement.
The maximum income that you will be able to take from your pension pot each year will be 100% of however much you’d be able to get from a comparable annuity. This will be based on tables put together by the Government Actuary’s Department.
The limits on how much you can drawdown will be reviewed every three years, and then annually once you reach the age of 75.
This will only be an option for the most dedicated pension savers (and, let’s be honest, the rich), as you’ll need to demonstrate that you have a secured pension income of £20,000. Should you qualify, you’ll be able to withdraw as much as you like from your pension funds each year, though these withdrawals will be subject to income tax.
According to the Treasury, around 50,000 people will be able to benefit from flexible drawdown, with an additional 12,000 qualifying each year.
What happens to your pension money once you die is also changing.
Currently, if you die before the age of 75, the lump sum that your family will receive from your drawdown funds is taxed at 35%. If you had chosen to put some of your pension pot into an alternatively secured pension at the age of 75, then when you die, your money would be whacked with a frankly outrageous tax rate of 82%.
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However, under the new plans, in both instances the money would be taxed at 55%. So an improvement for those dying after the age of 75, but a hit for those dying earlier.
So, who really wins as a result of these government changes?
The obvious winners are the well off, as they can now enjoy far more flexibility in terms of accessing the money they put aside for their pension.
Indeed, some critics of the changes have said that the only real beneficiaries are the richer elements of society who have been put off pensions altogether by the poor returns offered by annuities, coupled with the fact that should you die after purchasing an annuity, your estate won’t receive a penny.
And while annuities will continue to be the best option for many pensioners, increased flexibility and choice over exactly what happens to the cash you put aside in your pension each month can only be a good thing. After all, research by MetLife last month found that 70% of us want to have the option of taking an income from our pension pots by the age of 65, with a quarter of us hoping to take advantage of our retirement savings by 60.
Related how-to guide
There are a lot of things to think about as you get closer to your retirement. But the early you start to prepare, the better.See the guide
What’s more, the fact that we will be able to adopt such a ‘mix and match’ attitude towards our pensions in future by combining annuitising and a drawdown can only make pensions more attractive, with investors more likely to put cash into their pension instead of ISAs or alternative investments.
It’s not enough
However, the Government still has a long way to go before it has finished revamping the pension industry. Just getting people saving into their pension in the first place is a big challenge – a study last year by Aviva and Deloitte found that the UK boasts the largest pension gap in Europe, with Brits under-saving by around £10,300 annually on average.
2011 is an important year in this respect, as the Government’s NEST (National Employment Savings Trust) scheme is due to be soft-launched in the spring. NEST will make it mandatory for employers to offer a defined contribution scheme to staff, in the hope that it will encourage all of us to start putting a few pennies extra aside for our twilight years.
It’s in all of our interests for the Government to ensure the scheme is a success.