Budget 2015: Pensions set for another overhaul

Couple walking
Image caption Pensioners will have the opportunity to cash in a pension annuity

Big changes to pensions have been announced previously by Chancellor George Osborne, and it was no different this time.

These are part of a package of pre-election promises by this government: none will become law before the country goes to the polls in May.

Annuities provide an income for the rest of your life, however long you live. After your death some annuities pay a smaller sum to your spouse or partner. These are often called "joint life" annuities.

Cashing in

The new proposal is that you will be able to cash in your annuity for either a single lump sum or a series of payments. This has obvious advantages. Pensioners can invest it in a different way in the hope of receiving a higher income, perhaps via a buy-to-let property. Or you could pay off your mortgage, reduce other debts, help children with university fees, or even go on holiday.

But cashing in an annuity may not be straightforward. How will the value of your annuity be calculated? Will it take into account your state of health, and how many more years you are likely to live? If you have a "joint life" annuity, will your spouse or partner have to consent to you cashing in the annuity?

Another issue is tax. The new rules will remove the penal 55% tax charge which applies now, but the cash you receive will still be taxable at your marginal rate.

If your annuity pays £50 a week, or around £2,000 a year at the moment, the £50 may not be taxed at all because it is within your tax-free personal allowance.

But a lump sum of, say, £30,000 would be taxed at 20%. As a result, you would receive £26,000, not £30,000. Depending on your circumstances, the lump sum could push you into the 40% or even the 45% tax rates, and may cause you to lose your personal allowance.

Another issue is whether the cash lump sum will block your access to certain state benefits.

The chancellor has promised that those thinking of cashing in their annuities will have access to advice. Factors that should be considered before deciding what to do include: the fees you will pay, the tax and benefit implications of the lump sum, and the drop in your income.

Lifetime allowance

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Image caption Workers will need to keep an eye on their pension pot

Currently, you can save up to £1.25m in a pension. If you save more than this, you are likely to pay tax on any excess at 55%.

The chancellor announced plans in the Budget that would see the lifetime allowance reduced to £1m from April 2016. If you already have more than £1m in your pension at this point, you will be able to "protect" an amount up to £1.25m. HM Revenue and Customs will set out the procedure for this in due course.

If you are in a final salary scheme, it is often difficult to understand how much your pension is worth. You should check this with the pension trustees before the new protection opportunity closes.

Once you have protected your pension fund, you must not make any further pension contributions, and neither must your employer. This needs care, especially for those in final salary schemes.

Annual allowance

You can currently save up to £40,000 a year in a pension. This is straightforward for those with personal pensions or those known as "defined contribution schemes", where you and/or your employer pay cash into your pension pot.

It is more complicated for those in final salary schemes. If you have a pay rise, the amount of your pension will increase, because your future pension reflects your pay.

So a pay rise of £4,000 a year may translate into a £48,000 increase in the value of your pension. This is more than the annual allowance.

That is why the chancellor ruled out any further reductions in the allowance, saying it would involve "penalising moderately-paid, long-serving public servants, including police officers, teachers and nurses".

What happens next?

Pension tax relief cost £34.3bn last year. Although this will reduce by between £300m and £500m a year as a result of the proposed change to the annual allowance, further cuts are likely, whichever party wins the election.

Possible targets are the national insurance relief given to employers and employees who make contributions into employer schemes.

Another is the 25% tax-free lump sum available from your pension. Further reductions in the annual allowance and lifetime allowance are less likely, because of the impact on public sector workers in final salary schemes.

No-one really knows what will happen after the election, but pensions will continue to be complicated.

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