Over the next couple of years you can expect huge changes in the pensions scene.
Sooner or later, these are bound to have a huge effect on everybody’s pension attitudes and experiences.
The current Scheme of a basic pension plus top-ups from SERPS and S2P will be replaced in April 2016.
The basic pension is now £113.10 a week and the new figure is predicted to be about £155, an apparent increase of almost 40%.
Most people will benefit from this change and it will eventually be easier to understand your State Pension entitlement. It is expected to cost the Government about £150 million a year but there will be losers from this change:
In addition to the State Pension, many people remained contracted in to the additional State Pension, formerly known as SERPS and more recently as S2P.
Since its introduction in the 1970s and major changes in the late 80s, this has provided a huge uplift for high earners who have remained contracted in throughout their working life.
They could see a significant reduction in the amount that they are likely to receive from the State.
In order to receive the full amount, you will have had to have paid National Insurance contributions for 35 years.
Thus, people who have worked abroad, had long periods of unemployment or other breaks in their NIC history, will receive less than the full amount.
For those who are due to retire shortly after the changes occur, it may be difficult to find out how much you are due.
The Department of Work & Pensions has not yet been able to create an IT system to work out how much each person will receive. It will be particularly complicated for those who were members of a contracted out Final Salary Pension Scheme because their entitlement will be reduced.
Those who are due to retire between April 2016 and August 2021 can call 0845 3000168 or 0345 3000168 or go to www.gov.uk/state-pension-statement to find out how much they will receive.
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This will have no impact upon people who are already in receipt of their State Pensions.
As far as we know, those who are claiming Pension Credit will also be able to continue to do so. For the vast majority of people, this will represent a beneficial change with increased retirement income.
Indeed, with the personal tax allowance now at £10,500 a year (for people born before 5 April 1948 and for everyone else from April 2015), a married couple with 35 years’ NIC can look forward to a joint tax-free income of about £310 a week.
The ability to encash your Pension Fund will take effect from April 2015. The Chancellor has recently clarified some of the rules.
If the holder of the Pension Fund dies before age 75, their beneficiary will be able to receive a fund up to the value of £1.25 million – tax-free!!!
Where the pension saver dies after the age of 75, the beneficiary can receive the whole of the fund but it will be taxed at the recipient’s marginal rate, presumably some at 20%, some at 40% and (in the case of large fund), some at 45%.
Nevertheless, this represents a huge improvement against the previous regime where the fund was taxed at 55%, irrespective of the age at death.
Again, there are winners and losers. Maximum flexibility is highly unlikely to be available to members of Final Salary Pension Schemes (also known as Defined Benefit Schemes). It is expected that many members will decide to transfer their fund on retirement to a private pension, thus enabling them to avail themselves of the regime.
Even this route will be closed to public sector employees. Local Government officers, Civil Servants, teachers, Police Officers etc. are all members of schemes which, to a greater or lesser extent, are unfunded. Such members will not be able to transfer into a private pension.
A huge rush to take advantage of the new rules is expected but people should be careful:
1. The earliest age at which one can draw from a Pension Fund (except for a small number of exempted occupations) remains 55.
Anybody who is told that they can withdraw from their fund at an earlier age should know that they cannot.
2. The maximum that can be withdrawn tax-free from a fund is 25%.
The rest is taxable at your highest marginal rate. Thus, you need to be very careful (and ideally seek advice) to maximise the amount that can be withdrawn each year without incurring adverse tax consequences.
Nevertheless, we expect huge numbers of people to take advantage of this new flexibility.
Previously a Pension Fund was locked up until your death and died with you.
Now you can make withdrawals during the period from age 55, minimise the tax consequences and progressively top up your ISAs each year.
In this way you will create an increasingly large fund which can be a valuable source of tax-free income or capital.
This is the Government’s latest great idea to encourage (possibly even force) people to save for their old age.
Stakeholder Pensions were a disappointing failure because there was no element of compulsion.
Employers are now required to offer a scheme and their employees are required to join it.
The firm will contribute 3% of your income, you will pay 4% and the taxman an additional 1%.
Thus, for those on an average annual salary of £26,000, £2,080 a year will be going into a Pension Fund.
Over a working life of 40 or 50 years (and making some assumptions for the growth in the value of the investments) people could easily finish up with a fund of £169,000 or more (in today’s terms i.e. adjusted for inflation).
In this example, £42,300 could be withdrawn tax-free (no change there) with the residue of the fund being withdrawn progressively to minimise the tax consequences.
You will still be allowed to “opt out” (in other words not to join the scheme). However, this decision will have to be reviewed at regular intervals, so it is likely that the vast majority of people would eventually finish up with a decent-sized fund.
What to do about all these changes
Clearly these will have a massive impact upon everybody. Whether the new flat rate pension equates to a “living wage” will depend upon individual circumstances.
We believe that those who can choose to withdraw their Pension Fund will opt to do so.
With additional tax-free income from ISAs and with the threshold at which one is required to pay tax rising progressively, most individuals can look forward to having a substantial tax-free income from age 55 onwards.
It is obviously essential that you receive advice on these matters and you should contact your adviser to set up a discussion.