2015 marked a revolutionary year in the pensions industry, and 2016 is set to bring further changes which could make saving for a pension seem even more challenging. Patrick Haines, Regional Director at Close Brothers Asset Management, looks at how you can plan accordingly to grow retirement income…
The pension reforms, which came into force in April last year, were the biggest change to pension legislation in almost a century. Aptly named ‘freedom and choice in pensions’ by the Government, the rules on purchasing annuities were relaxed and those in Defined Contribution (DC) schemes were offered new ways to access their pension savings. For instance, individuals at retirement now need to decide whether they should purchase an annuity, cash in their pension, or stay invested and drawdown income.
Equally, as a result of these changes, those in a DB scheme are now likely to consider whether they should transfer out of a Defined Benefit (DB) scheme to take advantage of the new freedoms. Our own research has found that over a third of employers have experienced staff enquiring about transferring from a DB to a DC scheme, showing a clear demand for more information. In the majority of cases, remaining in a DB scheme is actually the best option for an individual, and transferring will only be suitable, in the main, for high net worth individuals so gaining the right, specialist advice to make an informed decision is vital.
As we head further into 2016, there is yet more policy change to come. Some is confirmed, some is still up in the air, with a proposed review of the pension tax relief system ahead. What we do know is that there are several changes to be implemented from April which could catch many individuals out if not addressed. For those not well-versed in financial planning, it can all seem bewildering. If individuals do not realise how the changes could affect them, they could end up not taking advantage of opportunities to maximise their retirement pot while they can. Not only that, but they could use up allowances without realising, unexpectedly increasing the level of taxation they may face.
With this in mind, we have explained three key changes which lie around the corner that individuals should consider as we approach the new tax year and the Chancellor’s 2016 Budget:
The new Lifetime Allowance (LTA): This will be reduced to £1 million and, while that may appear to be a large amount as it is, it can be easier than it seems to end up on the threshold of this allowance. Take a generous final salary scheme, with the addition of inflation to grow it over the years, and suddenly individuals could find themselves in this category. One option to consider is the Fixed Protection 2016, which offers a protected lifetime allowance of £1.25m, but this itself has a deadline: contributions must end by 5 April (before the end of the tax year), so there is a limited window of opportunity to maximise contributions.
Reduced annual allowance: This is another change that individuals could unexpectedly find themselves hit by. The tapered reduction in the annual allowance for those earning over £150,000 will mean that, for every £2 of income over this, the level of tax-relieved contributions will fall by £1. Even something like a bonus could easily bring someone up to this level, so keeping an eye on contribution levels is important if individuals want to ensure they don’t end up facing an unnecessary cut.
The new flat rate pension tax relief: A prospective change to tax relief means parting with the current system of tax relief on contributions according to an individual’s marginal rate of income tax. This current system means those paying higher rates of tax receive more relief, and – while it may seem surprising – those in this category are certainly not in the small minority. There are approximately 4.6 million higher-rate tax payers in the UK, so a huge number of individuals will be affected should this be announced in the Budget. It’s therefore even more important that time is taken to look at how contributions could be hit in the long-term, and indeed, how individuals can make full use of the current system ahead of a change.
Tax is a complicated issue, and it’s understandable that these changes could encourage individuals to simply bury their head in the sand, rather than proactively alter their plans or speak to an adviser. Complexity aside, for those a long way from finishing their career, planning retirement can seem like an intangible goal and one that takes second place to buying a home, paying for school and university fees and even holidays.
The fact is, starting to save earlier will allow individuals to have more chance of continuing the lifestyle they enjoy in retirement. However, it is crucial that any such saving is smart and informed. By understanding and taking advantage of allowances available, combined with an investment strategy, building up a pension pot can be done as efficiently as possible. This is where financial advice can pay dividends.
Equally, for those at or nearing retirement who are trying to make sense of the original reforms and the changes immediately ahead, seeking the help of a financial adviser will help cut through the complexity.
Setting a financial plan is paramount. Identifying life and retirement goals, analysing your individual financial circumstances, and plotting out what changes will affect you is part and parcel of this plan for retirement. This can then be reviewed and stress-tested as the years go by, and ensure that it takes into account any additional reforms that are bound to be introduced. Retirement should never be about taking a step back in your lifestyle, and taking small steps forward by planning early will make sure this isn’t the case.
Patrick Haines, Regional Director at Close Brothers Asset Management