Mark Barrett, Accountant at Cannon Moorcroft and a Sage Business Expert, offers his thoughts on the changes to pensions announced in the recent budget. If you have any questions for Mark, post them in the comments section at the bottom of the article.
I've taken slightly longer than I usually do to respond to this year’s budget due to the curve ball change to pensions announced in the budget as well as several balancing points to partner with the pension announcement.
Pension lowdown
From April 2015, any member of a defined contribution pension scheme over 55 will be able to withdraw their pension pot as and when they want, subject to their marginal rate of income tax in the year of withdrawal.
This is the most significant change to pension legislation since the regime was introduced in 1921 and has far reaching effects, some of which may have an adverse effect on larger businesses.
Already the markets have responded with sharp falls in the share price of annuity providers and an increase in the share prices of investment advice providers.
There have also been the expected political gaffs jumped upon by the media, with the pensions minister Steve Webb saying that "If people do get a Lamborghini, and end up on the state pension, the state is much less concerned about that, and that is their choice."
But with the average pension pot being worth £25,000, there won’t be many Lamborghini’s being bought with pension funds. The Lamborghini Huracan, unveiled earlier this month at the International Motor Show in Geneva, is to be sold at about £165,000.
On Friday after the Budget I sat down with an Independent Financial Adviser (IFA), a Charter Tax Adviser (CTA) and a representative of one of the country’s leading providers of Self-Invested Personal Pension (SIPP) and small self-administered scheme (SASS) to discuss the implications of the changes.
It was generally felt around the table that most people who contribute to private pensions are generally more risk adverse than those who don’t, and would therefore be less likely to blow their pension pots on parties, cars and cruises. When it actually came to the point of being able to take the money, people’s concerns for their future well being will most likely cause them to make conservative decisions.
Other announcements
With this in mind, there were other announcements outlined in the Budget that intentionally partner with the liberation of pensions.
There is the Pensioner Bond savings scheme, available from January to everyone over 65, which pays fixed interest rates of 2.8% for a one-year bond and 4% for a three-year bond.
Also announced is the rise in the amount of Premium Bonds a person can own from £30,000 to £40,000 in June and £50,000 in 2015, with the number of £1million winners being doubled.
Additionally there is the merging of cash and share ISA’s into a new single ISA with an annual tax-free limit of £15,000.
This all neatly comes together with another announcement that from 6 April 2015, the maximum amount of an eligible individual’s savings income that can qualify for the starting rate of tax for savings will be increased to £5,000 from £2,790, with the starting rate reducing from 10% to nil.
Which effectively means that incomes under £15,000 will pay no tax on their investment income, benefiting those entering retirement with modest savings.
So for those who face having to buy an annuity, which is effectively a fixed rate bond for the rest of their life, they can now invest in short to medium term bonds and take advantage of improvements in the markets, but are also open to falls as well. As the current annuity market yields are relatively low, now isn't generally seen as a good time to buying annuities, so these alternative investments may be quite attractive.
One aspect that gave rise to some concern was the access to free and impartial advice for everyone who wanted it, as there are currently only about 21,000 IFA’s in the UK. The detail on how this is to be administered, paid for and country wide coverage achieved are yet to be seen, but so far it’s difficult to see how the numbers will stack up.
This was based upon the collective experience around the table that currently most people take their 25% tax free lump sum, but don’t actually splash out on all of it, but use it to help children/grandchildren, pay off mortgages or make house improvements. Some do splash out on a holiday of a lifetime or a new car, but because of the tax implications if they were to draw down their whole pot (up to 40% if it’s a large pot), we felt that most would be happy to use the tax free lump sum, but not their whole pot for these type of purchases. Most people who are savers will still want to keep a nest egg intact.
It could be good news for SIPP and SASS providers though, as more people start to think differently about their pension options. These types of pension investments may become more attractive, particularly as the pension pot is transferred into these investments rather than being drawn down, tax paid and a net amount being invested. Of course any investor still faces the decision at a later date whether to draw down all or part of the pot.
A spin off effects may be that higher rate tax payers, who currently get 40% tax relief on pension contributions up to £50,000 pa (£40,000 pa from April 2014), can draw down these contributions in the future at a lower rate if they stop being higher rate tax payers e.g. stop working and therefore their income falls below the higher rate thresholds.
Less attractive: bonds and shares
Another spin-off that is less attractive is the difficulties that the bond and shares markets may face, pension providers are probably the largest and most active participants in these market, and with lower funds available to them to invest, the price of shares may fall and the cost of bonds to their issuers may rise. Many businesses rely on issuing bonds to raise capital for their businesses instead of borrowing from banks as it gives them the certainty of a fixed rate of interest when they are planning ahead. If there is less demand for bonds from pension providers, then the laws of supply and demand say that lower demand causes increase rates, and therefore businesses will face having to either issue bonds at higher rates or seek other forms of funding.
'This increase in the cost of debt for businesses may slow down the growth in the economy as businesses choose not to fund projects that would increase their growth due to the higher costs reducing the profitability of the projects.'
Final thoughts
So generally around the table, the mood was positive, although there are concerns on how it will all pan out and fears that unscrupulous people will be looking to get in on the action for their own ends.
Certainly as accountants we expect to busier in the future, although we can’t offer investment advice, we will be running the numbers for clients considering investments so that they will be better able to make informed decisions on their investment options.