Why is it important to understand complex pension rules?

To many people, pension rules seem like a minefield, full of traps and pitfalls for the unwary. If you have a higher income, multiple or large pension pots or more complex requirements, retirement planning and pension drawdown can be even more complicated – and there are a lot of pension rules to follow.

As well as being complex and numerous, the rules around pensions can change every year with the government’s Budget Statement. In fact, in the 15 years between April 2006 (with the heralding of ‘pension simplification’ rules) and March 2021, there have been 28 Budgets and Autumn Statements with no less than 24 including changes to pension rules. If anything, pensions have become more complex.

Altogether, it’s an area that warrants close attention. Pension rule changes could affect your circumstances – whether you are building your pension, thinking about retirement or already in pension drawdown. 

What are the current pension rules?

Pension freedoms 

In 2015, the UK government introduced a number of changes around ‘pension freedoms’ that provide retirees with greater access to their pensions.

In summary, the key pension rule changes gave anyone aged 55 and over the freedom to access their pension however they wanted. There were also changes to who could receive death benefits and how they are taxed.

Other pension rule changes included:

• Accessing the whole of your pension – and taking the entire amount as a lump sum, paying no tax on the first 25%, with the rest taxed as if it were a salary at your income rate
• Not having to buy an annuity at age 75
• Accessing income drawdown schemes that were previously only available to wealthier pensioners.

Pension drawdown

The pension income drawdown rules now give you six main options:

1. Leave your pension for now and take the money later: this means you decide when you take your money. You might have reached the normal retirement date but that doesn’t mean you have to start drawing on your pension now. If you do decide not to take your money, you should evaluate the investments and charges under the contract.
2. Acquiring a guaranteed income through an annuity: you can use all or part of your pension pot to buy an annuity. It provides you with a regular and guaranteed income, with different types of annuity available at different costs, depending on your attitude to risk and preferences in retirement.
3. Establishing an adjustable income: you can typically take up to 25% as a tax-free cash sum. The rest of your pension is invested to give you a regular (taxable), if applicable, income in retirement.
4. Taking cash in tranches: you decide when and how much you take. Of the money you withdraw, 25% is tax free and the rest is taxable; this is available to anyone aged 55 or over.
5. Encashing your provision all at once: this is a possible option, but you should consider carefully before choosing it. Find out exactly how much tax you will need to pay on the amount you withdraw and have a clear understanding of how you will fund your retirement.
6. Mixing your options: you don’t have to choose a single option; instead you could use a blend of the above strategies.

This short video provides further information about the pension drawdown rules and your options if you are thinking about retiring.

What are the pension rules for income drawdown vs buying an annuity?

You can now take an income directly from your pension fund, which means you can remain invested while drawing on your pension. Income drawdown has arguably never been so attractive to retirees, as annuity rates have been in freefall since the UK’s vote to leave the EU. For example, as of 30 April 2020, a 65-year-old could only expect an annuity income yield of £4,891 per annum from a pension fund of £100,000 (based on a single life, level, no guarantee basis)*.

Our wealth planning experts will provide retirement advice to make sure you do not fall foul of the pension drawdown rules, and help you set up a retirement plan to suit your individual circumstances.

What are the pension rules around the pension lifetime allowance?

As well as the pension drawdown rules, there are rules as to the overall limit someone can accrue into their pension during their lifetime before a tax charge applies, known as the pension lifetime allowance (LTA) limit. At its height, the lifetime allowance was £1,800,000. It is now £1,073,100 and frozen until 2026.

Our expert wealth planners will consider whether you are saving too much – i.e. whether you are likely to exceed the lifetime allowance and incur a tax charge on the excess amount in your pension. You may need to consider applying for protection. You should also factor this into your pension drawdown options, as the tax you will have to pay on this excess amount depends on how it is withdrawn.

If you think you are nearing the lifetime allowance, please read what our experts have to say here for more information. Seek expert retirement advice to see whether there may be other, more tax-efficient ways for you to continue saving for retirement.

What are the pension rules around the annual allowance?

The annual allowance for pension savings is currently £40,000 for most individuals, although there are certain circumstances where this could differ.

This allowance limits the amount of tax privileges available on your pension savings, as any contributions over this annual allowance may attract a tax charge.

For high earners, the tapered allowance may also be a problem. Currently, people with a taxable income over £240,000 in a year have their annual allowance for that tax year tapered. For every £2 of ‘adjusted income’ over £240,000, their annual allowance is reduced by £1 subject to a minimum annual allowance of £4,000. Someone with an adjusted income of £312,000 or more in a tax year will have a £4,000 annual allowance. The calculations around ‘adjusted income’ are complex but your wealth adviser will be able to do them for you.

If you are caught by this restriction you might wish to reduce the contributions you (or your employer) are making to your pension fund. Otherwise you might be liable for an annual allowance charge.

The money purchase annual allowance is another consideration if you are making use of the pension freedom rules and withdrawing money from a defined contribution pension scheme. This can also restrict your annual contribution to £4,000.

Your CGWM Wealth Adviser will help you take stock of your income and work out what your maximum yearly pension contribution will be.

What are the pension rules for how a deceased individual’s pension is taxed?

The 2015 legislation introduced a change in the tax treatment of deceased individuals’ pensions.

Beneficiaries pay tax at their own income tax level, with the money they receive added to their earnings to calculate this – unless the person who dies is under 75, in which case there will be no tax to pay. This means that leaving some of your pension to your estate may be a tax-efficient way to plan your legacy.

If you are nearing retirement, you may find our article on top pension tips if you are about to retire helpful.

Helping you understand how pension rule changes affect your retirement plans

If you’d like help to ensure you take best advantage of new or old pension rules, our wealth planning team is here to help. At Canaccord Genuity Wealth Management, we offer retirement advice via our independent wealth planners and can do this on an ongoing/annual basis so each year we work with you to maximise your pension contributions and savings.

*Source: IRESS

If this article has interested you and you would like to meet one of our wealth planners or have any questions, please get in touch for more information on +44 02 7523 4500 or book a free consultation.

Alternatively, read more:

• Post-COVID-19 tax planning: what can I do to mitigate tax rises?
• What to do before 6 April 2021: your essential six-point financial planning checklist
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• What to think about when reviewing your retirement plans
• Will I run out of money? How does cash flow modelling work?
• Post COVID-19 Wealth Planning Guides
• How can tax planning ensure you make best use of your pension annual allowance?