The Chancellor’s surprising Budget changes to the pensions regime obviously caught the opposition on the back foot. Given the complexity of current pensions legislation that’s probably understandable.
It was refreshing, though, to see some move away from the ever tightening grip of the state on the way we conduct our affairs towards a greater degree of freedom and choice. As a pension specialist, I certainly welcome this change which should make life easier for many and help rebuild some long lost faith in using pensions for retirement saving.
The idea of allowing people to choose how they use their own money was a radical one, but it hasn’t come before time. There’s a long history of government initiatives in the area of savings and investment that either didn’t work at all or resulted in unintended consequences. Indeed, the whole minefield of pensions legislation is an example of good ideas spoiled by excessive meddling.
So what has actually changed?
The new freedoms are not really new. We’ve had ‘Flexible Drawdown’ for a while now, which allows anyone with total guaranteed pension income of over £20,000 a year to take as much as they like from their accumulated funds. The Budget brought this figure down to £12,000 a year, meaning that someone with a full basic state pension plus at least £6,200 from a final salary scheme or annuity can now withdraw any amount they like from any additional ‘money purchase’ funds – such as a personal pension plan – that they own.
As from next April, this lower minimum will be cast aside, and anyone over the minimum age for withdrawal, currently 55, will have full unfettered access to their funds at any time.
So what’s the catch, you may well ask? Why are the Government being so generous with your own money?
There’s a simple, one-word answer to this. Tax.
Any amount you draw out will be treated as taxable pension income in the year of withdrawal, so if you are already a taxpayer you’ll immediately lose 20% in tax. And if your other taxable income plus the withdrawal takes you into the higher tax band, that could become 40% or even 45% if you breach the top tax rate threshold.
Steve Webb, the Liberal Democrat Pensions Minister, was widely reported for commenting that anyone could use their pension fund “to buy a Lamborghini,” if that was their wont.
But queues at Lamborghini dealerships seem unlikely to appear. With a price of at least £135,000 for the cheapest model, an individual would need to withdraw at least £180,000 and probably much more to afford their dream car, even taking into account that a quarter of the fund could be taken tax free, in order to have enough left for the car after deduction of income tax. That’s why the Chancellor has forecast a bulge in tax receipts after the changes come into effect.
This kind of spending is likely to be well beyond the means of most pensioners. According to reports, the size of the average pension pot stands at around £25,000. However even this figure takes into account the significantly fewer but statistically important number with funds worth hundreds of thousands. One estimate suggests that a large segment of the population has less than £4,000 in their pension fund.
This low reliance on pensions could be to do with the law of unintended consequences I mentioned earlier. Successive governments have appeared hell-bent on a witch-hunt against the entire pensions industry, with decades of negative publicity and oppressive legislation. Is it any wonder that the average man or woman is now completely antipathetic towards the whole subject?
Now more than ever people need good advice, if no longer about which annuity to buy (although that will remain the best option for a minority) then about how to make the most of their fund and pay least tax. For very many people, carefully investing and managing their withdrawals over time to match their tax and personal circumstances – something we at Chesterton House have been doing for our clients for years – will be easily their best option as a way to make their funds last into advanced age.
The Chancellor’s changes may just have ushered in a new era of personal responsibility for your own retirement planning. If so, that would in my view be a Very Good Thing. What it does require, though, is a new breed of professional, independent advisers who can help people to negotiate this complex minefield with confidence. Frankly the personal financial advice industry hasn’t been in a fit state to deliver this before, but recent changes to the minimum qualifications required and the way in which advisers are remunerated are already having an impact and consumer confidence in advice should begin to rise.
With the future financial wellbeing of millions at stake, this is too important an issue to get wrong. Let’s hope that the Budget changes are just the first step into a brave new world of personal freedoms and the inevitable responsibilities that go with them.