On 9th December 2010 the Treasury announced a new retirement framework that sees the arrival of Capped and Flexible drawdown, replacing the previous USP, unsecured pension, and ASP, alternatively secured pension, both more commonly known as income drawdown. Firstly Let us start with the difference between the two new Drawdown structures:
- The ‘Capped Drawdown’ will operate in a similar way to current USP, other than it is clearly seen as vehicle to provide a sustainable income for life. 120% GAD maximum level income drawdown is replaced with a new maximum level equating to 100% of the prevailing annuity rate. Interestingly this will not be the providers own rate, or average of the top three as it is for Investment linked annuity but a new GAD rate.
- The ‘Flexible Drawdown’ will allow the client to take as much from their fund as they wish, which will be subject to income tax, so long as a Minimum Income Requirement, MIR, has been met.
Managing Income Levels
Income levels will need to be reviewed every three years up to the age of 75 and then every year.
The Minimum Income Requirement
The MIR is being set at £20,000. This will include state pension benefits; final salary pensions; and level lifetime annuities. It will not allow purchase life annuities, or non-lifetime incomes to be taken into account. The limit will be reviewed by HM treasury at least every five years and changed at their discretion. “The MIR is the same for all ages.” The MIR applies to each individual – no allowance for couples.
The £20,000 annual income does include the state pension, which we can state as £5,078 per annum, leaving an income requirement of £14,922. To achieve this on a typical annuity rate today would need a pension fund of approximately £230,000.
Both of the new structures have a new tax treatment on death where the fund passes to the clients estate in the form of a lump sum. HM Treasury has stuck to its guns and maintained the 55% tax on the fund, on the premise that people with these funds will probably have had higher rate tax relief along the way.
On death it appears that the new options will be:
- Maintenance of the drawdown arrangement for the dependent
- Return of Fund with a 55% ‘Recovery Charge’ on funds held in drawdown
- Full Fund pass over for the provision of a dependents pension
- Return of Fund donation to charity with NO TAX
Under the proposed reforms, Inheritance Tax, (IHT), will not typically apply to lump sum death benefits after age 75.
Funds can still pass to a dependent free of this tax so long as the money is being used for the provision of income.
Most disconcerting is that death benefits for all pensions, where death occurs post 75, will be subject to the 55% tax charge. We can say this is better than before – because an annuity would have had to have been purchased, but still – this is a very high tax charge if you have never had higher rate tax relief. The justification for the rate in the response to the“ consultation is stated as:
“The recovery charge will only apply in cases where an individual has unused pension savings remaining upon death. Typically this will occur where that individual has been in a drawdown arrangement. While many individuals will move between different income bands over their working life, HMRC estimate that around 75% of individuals currently in drawdown will have received most of their tax relief at the higher rate.”
We expect this to be an issue that will receive further challenge, because for the ‘ordinary person’ the message must now be – Good news you don’t have to buy an annuity when you get to age 75, bad news is that if you die after 75 your beneficiaries can only have the money with a 55% tax charge!
Serious Ill Health Lump Sums
The proposals introduce the payment of a lump sum, equating to a return of Fund, when serious ill health is diagnosed. As with the Death Benefit scenario this benefit is subject to the recovery charge of 55% when the person is over 75 years old. Importantly this does not apply before 75.
Impact of Existing Plans
Existing arrangements will come under the new regime with effect from the 6th April 2011. The impact of the new ‘Capped Drawdown’ limits will affect existing arrangements in different ways depending upon when 75th birthday falls, so if it falls:
- On or after the 6th April 2011, the new limits apply from the start of their next reference period to begin on or after that date;
- Before 6th April 2011, from the start of the drawdown pension year in which the 6th April falls. (This is not likely to be a large number of people in our opinion). Except for those who
- Between 22nd June 2010 and 5th April 2011, the changes will have effect from the start of their next drawdown pension year to begin on or after 6th April 2011.
What you cannot do!
- • Have a flexible income drawdown and continue to get tax relief on pension contributions.
- • Claim tax relief on contributions made after your 75th Birthday.
Additional Issues Covered
- The Lifetime Allowance reduces to £1.5 million w.e.f 6th April 2010
- New Fixed Protection rules are introduced for individuals with funds already over £1.5m
- Carry Forward of unused allowances will be allowed from the previous year
- No tax relief will be granted for contributions made after 75th Birthday
- Trivial Pension limits remain at £18,000
Source: Retirement Partnership