Pension Reforms: How will they affect you?

The pension reforms taking the UK by storm were announced by George Osborne at the end of 2014 and were hailed as the biggest change in UK pension history. As of April 6th 2015, those aged 55 and over now have full control of their retirement finances.

The new changes mean that the old requirement of purchasing an annuity is no longer enforced, opening the door to other more flexible options, including accessing your pension as a drawdown or even as a lump sum. Of course annuities will still be available to those who choose to purchase one, but they are no longer a legal requirement when gaining access to your retirement fund as once it was. Far from the 'one-size-fits-all' mentality that once dominated the pension landscape, these new reforms seek to give those nearing retirement age complete flexibility and freedom to choose the financial strategy that works for them.

Traditional pension pots

In the UK, most savers have three defined pension pots:

  • State pension
  • Self-invested personal pension (SPP)
  • Employer pension
  • State pension
    A payment made by the Government to all UK residents when reaching State Pension age if you have paid National insurance contributions throughout your working life. The current maximum state pension is £155.65 per week, but this increases each year by a minimum of 2.5%.
  • Self-invested personal pension (SPP)
    The name given to a UK government approved pension scheme which allows individuals to make investment decisions from a range of HMRC investment options.
  • Employer pension
    All employers must offer a workplace pension scheme which you, your employer and the government pay a pre-agreed amount into every month.
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Overview of the changes

The Autumn Statement released in December 2014 heralded huge and revolutionary changes for the UK pension landscape. For years, UK savers have been legally obligated to purchase an annuity with their retirement funds, as the Government has long seen this as a 'safe' option to ensure guaranteed income in retirement. However, December 2014 saw Chancellor of the Exchequer George Osborne spearheading a new era of pension savings - for the first time, annuities are now a choice rather than an obligation.

Choice was definitely high on Osborne's agenda - the point was highly reiterated that those nearing retirement age should have the choice as to how they invest their retirement funds. Therefore, as well as changing the legislative obligation to purchase an annuity, Osborne also announced that there will be new options available for those nearing retirement age as an alternative to annuities: there is now the option of a pension drawdown, as well as the option to withdraw the whole pension pot as a lump sum.

Drawdowns offer pensioners the ability to withdraw some or all of their personal pensions funds, allowing for full financial flexibility that annuities specifically do not offer. What's more, Osborne announced that this drawdown option will also be somewhat tax-effective, with the first 25% of the pension pot available to withdraw tax-free.

Annuities are still an option for those seeking a safer option, but for years people have been disillusioned by the low annuity rates, instead wishing for the chance to make the most out of their nest egg by taking on more risk buy in the hope of generating more flexibility and better returns. These new pension changes were made to encourage those nearing retirement age to make savvy financial choices that suit them, rather than forced to adopt a generic, and overly 'safe' approach in pension funds.

1.

Annuities

Annuitising a pension involves trading an entire pension fund for a secure and guaranteed income for a set amount of time (with the most common being the 'lifetime annuity' which guarantees income for the duration of a person's life). There are lots of different annuities available (from lifetime and enhanced annuities to more specialist ones like Purchased Life (PLAs) and investment-linked annuities), but ultimately you are entrusting your entire pension pot to an external party who will provide you with a pre-agreed amount, depending on the type of annuity chosen.

2.

Drawdown

A drawdown is a policy whereby your pension remains invested, but still allows the policyholder to take both an income and a lump sum from the fund at any time. Within this policy, there are two kinds of drawdowns available; a Capped Drawdown, which limits how much you are able to withdraw as a lump sum, whereas a Flexible Drawdown allows for complete freedom by the policyholder in when and how much is taken from their pension pot, while the rest remains invested.

3.

Lump sum

Pension holders can now for the first time take their pension as a lump sum and use their funds as they wish. Much like the drawdown facility, the first 25% of the pension is tax-free, while the remainder is subject to the policyholders marginal rate of income tax (less the current personal allowance, which for the tax tear 2016-17 is £11,000). This allows pensioners for the first time to invest their retirement fund however they like.

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