Detail of UK pension reforms emerges as Taxation of Pensions Bill published

Out-Law News | 15 Oct 2014 | 12:57 pm | 3 min. read

Legal changes that will allow defined contribution (DC) pension savers to access their savings more flexibly have moved one step closer following the publication of the laws for debate by the UK parliament.

Once approved, the new Taxation of Pensions Bill would allow those aged 55 or over access to their DC pension savings in whatever form that they wish without necessarily having to purchase an annuity, subject to their marginal rate of income tax. The new regime is due to come into force in April 2015.

Pensions expert Simon Laight of Pinsent Masons, the law firm behind Out-Law.com, said that although the legislation had previously been published in draft, the bill would give pension providers the opportunity to consider how best to market the new flexibilities.

"Whether pension schemes and pension providers choose to offer this flexibility comes down to cost," he said. "Some of the complexity has been removed, but not all. Running so-called banking style pension accounts, from which you can withdraw as little or as much as you wish, requires manual intervention or introduction of sophisticated new systems – both costly to implement. This is why current flexible pension products come at a cost, and are perceived by some to be expensive."

"The government wants the pensions industry to deliver low-cost flexibility. Can providers do this more cheaply, especially with smaller pot sizes being involved? Yes, but you need expensive new systems and for that you need scale. We will see a 'land grab' as providers rush to develop new banking-style pensions and seek to capture market share - it's a dash for cash," he said.

Under current rules, DC pension savers are entitled to withdraw 25% of their savings as a tax-free lump sum once they reach the age of 55. They can then purchase an annuity or drawdown product with the remainder of their savings, with future lump sum withdrawals subject to a 55% tax charge in order to discourage the practice. From April 2015, savers will be able to take a number of smaller lump sums instead of a single lump sum and each time 25% of what they withdraw will be tax free with the rest taxed at their marginal rate of income tax.

Laight said that this outcome was technically already possible under the existing regime, although it was more complex to do so and was often seen as being more expensive.

"This is called 'phased vesting': you divide your pension pot into portions and vest one portion only," he said. "Of that portion you take 25% tax free and leave the rest undrawn or take it as lumps of income. When you want another lump sum, repeat the process. The flexibility is already there, but it involves buying a drawdown product to make it happen."

"The changes set out in the Taxation of Pensions Bill create a simpler mechanism to achieve the same outcome. It is a simpler concept - you ask your pension scheme or pension provider to let you take out a number of smaller lump sums, without having to buy a drawdown product," he said.

At the end of last month, the government announced that it would also remove the 55% tax charge when unused pension funds are passed to a nominated beneficiary on the saver's death. This change will also apply from April 2015 and apply to the remaining funds in a DC pension which is in a drawdown account or value-protected annuity or which is still uncrystalised. The nominated beneficiary will be able to access those funds flexibly, at any age, and will only be liable for tax at their marginal rate of income tax if the deceased was 75 or over.

"People who have worked hard and saved all their lives should be free to choose what they do with their money, and that freedom is central to our long-term economic plan," said George Osborne, the chancellor of the exchequer, ahead of the bill's publication.

"From next year they'll be able to access as much or as little of their defined contribution pension as they want and pass on their hard-earned pensions to their families tax free. For some people an annuity will be the right choice whereas others might want to take their whole tax-free lump sum and convert the rest to drawdown. We've extended the choices even further by offering people the option of taking a number of smaller lump sums, instead of one single big lump sum," he said.