Super-annuation ahead

Some big pension changes affecting independent practitioners and their private pensions are about to kick in. Patrick Convey explains the opportunities ahead for doctors

Rentnerpaar im CabrioletIn April, savers in the UK will see the biggest changes to pensions in decades. Unusually for the industry in recent years, there is actually good news.

Many column inches have already been printed regarding savers’ future rights to take as much as they want, when they want, from their private pension pots in the form of cash lump sums.

But these so-called pension freedoms have arrived very quickly, causing some degree of confusion and an industry which is not quite ready to embrace the revolution.

Even the regulatory body, the Financial Conduct Authority (FCA), has announced it is introducing fairly last-minute additional protections for savers.

What do the changes actually mean?

Senior doctors aged over 55 – and crucially, their spouses – will no longer need to buy an annuity to provide income until they die.

Savers will not be limited to a once-only chance to take a single tax-free lump sum. Instead, you will have complete access to your pension savings – subject to your marginal rate of income tax in that year – effectively dipping in as you need to.

It is this key area which has generated those ‘freedom’-related headlines. After many years of retirees being locked into poor annuity rates, the news provides some welcome relief.

In practice, however, this is likely to be of greater benefit to the spouses of doctors where pension funding has been made from partnership earnings or limited company profits and where their rate of income tax is likely to be much lower in retirement than their higher-earning partner.

Flexible drawdown

Medical professionals are likely to ease themselves into full retirement over a number of years. For this reason, many consider ‘income drawdown’ which lets you draw an income from your pension pot while leaving the remainder invested.

You choose how much lump sum or income to take and where the fund will be invested. Not only will you keep control of your capital, you will have increased flexibility should economic or personal circumstances change.

An alternative is ‘phased retirement’ where your pension savings are split into segments, giving you control of which segments you want to turn into an income and when – useful if you don’t want to retire completely.

Your cash flow can then be shaped to reflect your circumstances at that time; for example, less income at the start if still working part-time. If you die, the balance of the fund segments not yet accessed can be passed on to loved ones outside of your estate.

Tax implications

One key consideration when taking your pension is tax. Making large withdrawals will lead to substantial income tax payments, so you may need to consider staging them carefully.

As savers access more of their pensions, the amount of extra tax collected by HM Revenue and Customs is expected to rise from £320m in 2015-16 to £1.2bn in 2018-19.

Before drawing any funds from your private pension, bear in mind the impact it may have on your annual allowance.

Savers who choose to draw down more than their tax-free lump sum of 25% from a private pension may see their annual allowance limit cut from the standard £40,000 to £10,000 per year once it is crystallised. Their annual allowance will then remain at that level for life.

This could cause extra confusion for those monitoring annual savings limits in more than one pension.

Recycling your pension?

Critics have argued that the new freedoms could allow savers to ‘recycle’ their tax-free allowance, whereby an individual boosts their pension savings by taking their tax-free cash and, as a result, increases their payments into a pension plan to gain further tax relief.

In response, the Government has proposed to limit the amount of pensions tax-free cash that can be ‘recycled’ at just £7,500 per year – a figure of £10,000 was originally anticipated.

Again, this is likely to impact spouses more than senior medical professionals, who may no longer be funding pensions due to lifetime allowance restrictions.

Passing on pensions

To add to the good news, the Chancellor announced that the harsh death tax due on private pensions will be abolished from April.

Doctors can now choose to pass their private pots on to loved ones tax-free, as pensions do not form part of a person’s estate for inheritance tax purposes.

Currently, pension pots are taxed at up to 55% on death once a person has started to take income or taken tax-free cash.

But, in the future, when someone older than 75 dies, their heirs will pay income tax at the marginal rate and no tax charge will apply if aged under 75 – subject to them having available lifetime allowance remaining.

Whereas, previously, independent practitioners may have stripped funds out of their personal pension or self-invested pension in retirement, this new move will make it much more attractive to keep pension funds invested and to pass these on to family members in the future.

The new rules will only apply to those who have their pension funds invested in income drawdown rather than in annuities, but it is still a very attractive option for higher-rate taxpayers.

A higher-rate tax-paying doctor could contribute to a private pension, enjoy tax relief on the sum and then leave it tax-free to loved ones if they die before 75. If they die after 75, it could be subject to only 20% tax if withdrawn by a basic rate taxpayer – a very useful inheritance tool, depending on an individual’s circumstances.

Maintaining your lifestyle

Your retirement might last two or three decades and few of us relish the thought of downgrading from our current standard of living. The onus is therefore on you and your adviser to ensure that you do not exhaust your funds before time.

Much has been made about the danger of pensioners going on a Lamborghini-buying spree once the pension freedoms come into play. In reality, those who have worked hard and saved throughout their careers are unlikely to throw caution to the wind in later life.

Evidence from Australia, however, where retirees have had greater access to pensions for some years, shows that with independence comes responsibility.

While Australians are generally credited with having greater pension provisions than the British, those ‘down-under’ were quick to realise that their high life expectancy – the world’s fourth longest – would need substantial funding. For research has shown that a quarter of Australians with superannuation funds at age 55 were found to have depleted those funds by age 70.

However, the far bigger problem for the majority of their older population was actually a failure to draw on their pensions.

A recent report showed that, faced with the risk of outliving their assets, savers were choosing to live more frugally in retirement.

This fear of consumption was not only leading to less-enriched lives but was impacting the Australian economy as a whole. Navigating their own financial futures was proving so challenging that many were drifting back to the relative safety of annuity-type products despite the poor returns.

Opportunities knock

Patrick Convey 4 webPensions are still the main tool for creating long-term financial security. After countless negative changes in recent years, these latest enhancements are to be embraced.

With careful planning, as well as providing tax benefits on contributions and a flexible income in retirement, pensions can now be used to pass on assets to future generations as part of an overall investment strategy.

Patrick Convey (right) is technical director of Cavendish Medical, specialist financial planners helping senior consultants in private practice and the NHS.

The content of this article is for information only and must not be considered as financial advice. Cavendish Medical always recommends that you seek independent financial advice before making any financial decisions. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor. The value of investments and the income from them can fluctuate and investors may get back less than the amount invested.