Pensions: everything you need to know for year-end

DISCLAIMER: The purpose of this insight post is to provide technical and generic guidance and should not be interpreted as a personal recommendation or advice.

The value of investments can go down as well as up and you may not get back the full amount you invested.

Lifetime allowance considerations

Although funds invested within a pension can grow tax-free, there is a limit (the lifetime allowance – LTA) on the total amount you can hold in a pension pot: funds in excess of the limit will suffer penalty tax charges when you start to take pension benefits.

The LTA reduced from £1.25m to £1m from 6 April 2016. You can elect for ‘Individual Protection 2016’ (IP16) to preserve your individual LTA at the lower of £1.25m or the actual value of your pension funds at 5 April 2016 (if they were above £1m on 5th April 2016). As with previous reductions, individuals can also preserve the earlier £1.25m LTA by opting for ‘fixed protection 2016’ (FP16). Although all contributions must have stopped from 6th April 2016 if fixed protection is chosen. The Government initially announced that the LTA would increase in line with the consumer price index each year from 6th April 2018. This was then changed and will remain at the current level of £1,073,100 until at least April 2026.

Stakeholder pensions

Stakeholder pensions allow contributions to be made by, or for, all UK residents, including children and grandchildren from birth. Consider making a net contribution of up to £2,880 (effectively £3,600 gross) each year for members of your family, even for those who do not have any earnings. You can also make pension contributions in respect of family members who do not work (i.e. have no relevant earnings) or cannot afford them.

If you make contributions to your children’s pension schemes on their behalf, they get the tax relief and the payments are treated as reducing their taxable income, so it could help keep them below the £50,000 income threshold at which they can retain the child benefit. The earlier that pension contributions are started, the more they may benefit from compounded tax-free returns.

Pensions freedoms

The popular pension freedom reforms that launched in April 2015 mean that people can now access their whole pension pot at age 55 and spend, save or invest the money as they wish. Savers can withdraw the whole pot in one go, although you might mistakenly run up a huge tax bill, especially if you were only used to being taxed at the basic rate through an employer. By withdrawing large portions of your retirement pot, the outcome may mean you move into a higher rate tax bracket.

Flexible access from age 55

Pension investors aged at least 55 (rising to 57 from 2028) will be able to access their pension fund as a lump sum if they wish.

From 2028 onwards, the Government’s intention is that the minimum pension age for private pensions should be ten years below State Pension age, although they are not automatically linking normal minimum pension age increases to State Pension age increases at this time.

The increase to age 57 will not apply to members of the various firefighters, police and armed forces public service pension schemes (commonly referred to as uniformed services pension schemes).

The Government intends to introduce a protection regime to apply to all types of UK registered pension schemes (occupational and non-occupational schemes) that will allow benefits to be taken before age 57 (but not earlier than age 55) after 5 April 2028 where a protected pension age is held.

Essentially, the protection regime will work by allowing anyone who is a member of a pension scheme by 5 April 2023 that had an ‘unqualified right’ in the scheme rules at 11 February 2021 to take benefits from their arrangement at an age below 57, to be able to take benefits at that younger age even after 6 April 2028. If protection does apply, this right will apply to all money paid into the arrangement.

Note 11 February 2021 was the date the initial consultation document was published.

The first 25% of a lump sum will be tax-free and the rest will be treated as taxable income and will be subject to income tax at their marginal income tax rate. Basic rate taxpayers need to be aware that any income drawn from their pension will be added to any other income received, which could result in them paying tax at 40% or even 45%.

You can also choose to take your pension in smaller lump sums, spread over time, to help manage your tax liability.

Since April 2015, some restrictions have been removed. A fully flexible drawdown will offer considerable freedom but highlights the need for expert planning advice.

Transferring a final salary scheme

If you have a final salary (e.g. defined benefit (DB)) pension fund, you may still be able to take advantage of the new rules to make unlimited withdrawals. However, to do so you would have to transfer some or all of your pension into a defined contribution scheme (DC or Money Purchase), there is a range of personal pension wrappers available. You should seek financial advice before transferring benefits as you could lose valuable benefits which need to be weighed against the new flexibilities.

Unfortunately, members of unfunded public sector DB schemes, such as the NHS Superannuation scheme won’t be able to transfer to DC schemes.

Reviewing your retirement plans

The new rules give considerable freedom of choice. Under the new rules, whilst nobody will be forced to buy an annuity at any age, those who wish to do so can and this may prove to remain the most appropriate solution for some people.

Clearly, it has never been more important to make the right choices about your pension fund, both about how you should carry on saving and how you should take the benefits These decisions will affect you for the rest of your life. It is essential, especially for those nearing retirement, to seek professional advice. Not only will an expert look at you pension fund, but they will consider your wider financial goals. They will also consider another aspect of the new freedoms outlined below.

Your pension pot: A tax-efficient way of keeping it in the family

Important changes are also taking place with regards to how pensions are treated in the event of your death. Retaining pension wealth within the pension fund and passing it to future generations is now an extremely tax-efficient estate planning solution, as it combines inheritance tax (IHT) free inheritance with tax-free investment returns and potential tax-free withdrawals. Indeed, it may even change the way we utilise our capital in retirement, possibly leading us to spend other funds before our pensions.

From April 2015, you can nominate who inherits your pension fund. It can be anyone of any age and is no longer restricted to your ‘dependents’. If death occurs before age 75, the nominated beneficiary can access the funds at any time, tax free. If the original policyholder dies after age 75, defined contribution pension funds can be taken in instalments or a lump sum and will be taxed at the beneficiary’s marginal rate as they draw income from it.

Additionally, the nominated beneficiary can appoint their own successor, allowing the accumulated pension wealth to cascade down generations, whilst continuing to enjoy the tax freedoms that the pension wrapper will provide.

Each time a pension fund is inherited, the new owner has control over the eventual destination of those funds.

This insight was originally featured in our Year-end tax guide for 2021/22.