What you need to know about pensions in 2016
Huge state pension changes and a tax relief overhaul are on the way
Pensions were transformed by the arrival of sweeping freedom reforms last April, but no one should expect any let-up in the pace of change in 2016.
The consequences of giving over-55s full control of their retirement savings have been overwhelmingly positive to date, with no real signs of people running riot with their cash, and some evidence that younger people are being galvanised to save more.
But as the fallout from pension freedom continues to be felt, two other very big changes are looming in the first half of 2016.
A huge shake-up of the state pension this April has already infuriated people coming up to retirement, as just one in three of them look set to qualify for the full £155.65 a week payout.
Meanwhile, everyone still saving up for their old age – so an awful lot of us – will be affected by Chancellor George Osborne’s wholesale review of the pension taxation system.
We’ll hear Osborne’s plans in the spring Budget on 16 March, but he’s widely expected to devise some new arrangement that downsizes the Government’s annual £34 billion pensions tax relief bill.
Whatever the finer details turn out to be, a more miserly pension tax regime will mean younger generations of workers ending up with smaller retirement pots in future.
It’s worth finding out more about these and other pending pension issues and how they might alter your retirement finances. Here’s what you need to know.
1) The state pension
The state pension will get a major overhaul in April, with the introduction of a new ‘flat rate’ payment to replace the unwieldy two-tier system.
The idea was to make the state pension simpler and fairer. But the changes have already prompted bewilderment and anger among savers who expected to get the full flat rate amount – recently finalised at £155.65 a week – then discovered after applying for state pension forecasts that they will end up with smaller payments.
This is because they contracted out of paying the additional state pension top-up and under-paid National Insurance during their working lives.
Confusion arose because it was initially understood that anyone who had made 35 years’ worth of full National Insurance contributions would nevertheless qualify for the full new state pension.
But the Department of Work and Pensions is assuming people who contracted out built up a certain amount of other pension with the money that wasn’t paid in extra NI contributions, and it is making deductions from their new state pension accordingly.
So, some people have 35 or even more fully contracted in years, but contracted out for some further years above and beyond that, and they are still facing deductions based on the DWP’s assumptions about the size of their other pensions.
Pensions Minister Ros Altmann has already admitted that the new state pension was ‘mis-sold’ to the public, and a publicity drive to explain it better is likely early in the New Year.
But in short, anyone who reaches state pension age after 6 April next year will receive the new state pension payouts, with or without deductions.
Those who have reached that age already or do so before April still get the old payout, which means the basic state pension plus additional state pension entitlements – S2P and Serps – that they accrued during their working years. The basic state pension will rise by £3.35 to £119.30 a week from next April.
However, people who retire under the old system are allowed to top up their state pension to receive higher payouts. They also have the option of deferring it under more generous terms than people will get in future.
It’s important to keep up to date with the state pension changes, and to make enough National Insurance contributions while you’re working to qualify for the maximum payout you possibly can in retirement.
That’s because the state pension provides a guaranteed income that remains the bedrock of most people’s retirement finances, unless they are very rich. Sometimes the state pension can end up being the sole source of income, aside from benefits if someone is very poor.
It’s not enough to fund a comfortable retirement though, so people are strongly recommended to save into a private or workplace pension as well if they don’t want to be left scrimping to pay for necessities in old age. This is Money Editor Simon Lambert wrote about this topic recently here.
But as he notes, the quality of most private sector pensions has declined dramatically in recent decades due to the closure of generous final salary schemes, which used to provide a guaranteed income for life on top of the guaranteed state pension.
Nowadays, most people working for private companies are parked in stingier ‘defined contribution’ pension schemes, and end up with a fairly unappealing choice between an annuity or income drawdown when they reach retirement.
Annuities provide a guaranteed income but can be poor value and restrictive, while income drawdown plans let you tap your savings gradually over time but are more complicated and involve investment risk.
People in defined contribution schemes are therefore likely to lean most heavily on the state pension, and need to take the most care to ensure they qualify for the full payout.
2) Pension tax relief
The Government is rethinking the £34 billion pension tax relief system.
Chancellor George Osborne launched a consultation on changes to retirement savings in his July Budget, and it looks like the current system of upfront tax relief on pension contributions is set for a major overhaul next Spring.
At present, the Government rebates all the tax on people’s contributions, whether you pay at the 20 per cent, 40 per cent or 45 per cent rate. Your pension is only taxed when you start making withdrawals in old age.
Osborne is expected to go further and introduce a flat rate of tax relief for everyone, perhaps set at 30 per cent, next year.
Tom McPhail, head of retirement policy at Hargreaves Lansdown, believes there will be significant changes to the way pensions are taxed, with an overall cut in the amount the Government is willing to put into our retirement savings in future.
He warns that the flat rate could be as low as 25 per cent, saying: ‘I do not think they are going to be generous.’
Meanwhile, the principle of everyone saving into a pension from untaxed income is already being undermined, with higher earners set to see tax relief slashed from next April.
The size of the annual allowance will be gradually reduced from £40,000 to £10,000 for those making between £150,000 and £210,000 a year.
Osborne might do some further tinkering with everyone else’s £40,000 annual allowance, or how much unused allowance people are able to carry forward from previous years. Savers are currently allowed to roll over unused annual allowances up to a maximum of £120,000, on top of their annual allowance in the current year.
Elliott Silk, head of employee benefits at financial services group Sanlam, thinks pension carry forward could be abolished altogether for higher earners, who are the main beneficiaries of this tax loophole.
Then there is the lifetime allowance – the total amount people can put in their pension pot during their lives and qualify for tax relief. The present plan is to cut this from £1.25 million to £1 million from the 2016-17 tax year, and index-link it to inflation from 2018-19, but this could be revised as part of a wider shake-up.
There is also a chance Osborne might reduce the 25 per cent of their pots people are currently allowed to withdraw tax free when they reach the age of 55, although this is considered far less likely.
Meanwhile, the option of pensions being taxed like ISAs – paying in from taxed income, and making tax-free withdrawals – sparked strong opposition when it was originally mooted, which might have scared off Osborne from going down this route.
Critics warn it would cause a raft of practical problems and involve trusting future politicians not to slap extra taxes back on later. Such a change would raise the threat of savers getting walloped twice if the changes unraveled by the time they retired.
3) Pension freedom
The popular pension freedom reforms launched last April mean that people can now access their whole pension pot at age 55 and spend, save or invest the money as they wish.
Savers can withdraw the whole lot in one go, although you might mistakenly run up a huge tax bill, especially if you were only used to being taxed at the 20 per cent basic rate through an employer.
This is because suddenly withdrawing big chunks of money might push you into a higher-rate tax bracket. Over-55s are already tapping their pensions for a host of reasons – to pay off debt, give money to family, fund home improvements, take holidays and become buy-to-let landlords. However, Prime Minister David Cameron personally announced a snap review of the reforms following a deluge of complaints from people who couldn’t access their retirement savings as promised.
Exit fee caps are under consideration following evidence that the pensions industry is imposing a mishmash of excessive and confusing charges on savers. Other common gripes include endless delays when people try to withdraw or move their money, and being forced to get expensive or unnecessary financial advice.
The Government might therefore look again at legislation to ensure all pension scheme providers make savers pay for financial advice if they want to:
1) Transfer or cash in a final salary pot worth £30,000-plus; or
2) Access a defined contribution pot with valuable guarantees – like death benefits or an annuity rate better than you can get on the open market – worth £30,000-plus.
Some pension providers go even further than this and insist people take financial advice if they want to transfer their savings into income drawdown schemes which involve investment risk.
The Government’s free Pension Wise guidance service could also be overhauled, amid fears that not enough people are booking appointments to talk through their options before making big financial decisions they might not be able to take back.
4) Financial advice
The lack of affordable and accessible money advice is under scrutiny in a new Government review of the finance industry.
This is investigating the so-called ‘advice gap’, which leaves people with modest means out in the cold, and other barriers that currently put people off seeking help from financial professionals.
The ‘Financial Advice Market Review‘ will consider all types of financial products – including savings, mortgages, insurance and pensions – and report ahead of the next Budget.
But the pension freedom reforms have sparked particular concern that people are in more need than ever of decent financial advice to help them navigate the system, or they risk squandering their pension pots.
The Pension Wise service offers guidance but not any personalised help, for instance about which investment funds to select for your income drawdown plan.
Unless you are well-off, getting money help has become harder since the big financial services overhaul which banned cosy backdoor commission deals in 2013.
Financial advisers now levy upfront fees and percentage charges on savings pots in exchange for their services, and some have stopped doing business with any but the most wealthy clients.
Many people also shun financial advice on the grounds that it is poor value for money, with some turning instead to online DIY investment platforms, which welcome their business and offer many tools and other resources but are essentially ‘execution-only’ services.
The review is being led by the Treasury and the Financial Conduct Authority, but an expert advisory panel of industry and consumer representatives is also involved.
Tom McPhail of Hargreaves Lansdown is hopeful the review will open up access to financial advice and plug gaps in the current system.
He believes there are technical solutions to giving people generalised money help, for instance if they have £5,000 in a savings ISA but no idea where to invest it.
5) Pensioner bonds
Hundreds of thousands of elderly savers opened a 12-month fixed pensioner bond earlier in the year, but they will see their rate tumble if they opt into one of National Savings and Investments’ rollover accounts.
At the start of 2015 – just before the general election – the Government-backed 65+ Guaranteed Growth Bonds came with a 2.8 per cent rate, with an opening balance limit of £10,000.
The new one-year rate is 1.45 per cent, the two-year 1.7 per cent, the three-year 1.9 per cent and the five-year 2.55 per cent, far lower than the attractive deals at the start of 2015.
The drastic cut to the one-year rate means a lot of pensioners will be looking to shift their cash again when their bonds mature early in 2016.
But This is Money has also discovered that savers who took out pensioner bonds will be barred from withdrawing their money by telephone call.
NS&I changed the small print, which means anyone who took out one of these deals has to use the post or internet to get a payout.
It means that even savers who took out a bond over the phone using a debit card now can’t simply give NS&I instructions over the phone to have their money and interest credited to a current account.
The three-year pensioner bond launched last year had a rate of 4 per cent, and people who put money into that will continue to benefit as before.
Read the original story on the This is Money website.