Yesterday, the most important reforms to UK savings policy in a generation came into force. Anyone aged 55 or over is now free to use their pension pot as they wish. They no longer have to buy an annuity, and can even take out some or all of it in cash. Whereas previously only those with large pensions could use drawdown to keep their money invested while taking an income, now that freedom has been extended to everyone.
This is a positive move. There was so much entrenched negativity around annuities, and poor rates had become a feature of the market. Flexibility for investors in when, how, and in what shape they take income is also very attractive.
For wealthier savers, the reforms will be less of a shift. The real game-changer is the abolition of the 55 per cent death tax, previously levied on the inheritance of a pension by loved ones (although there is a 45 per cent tax charge for those aged 75 or over at death if a lump sum payment is made). Since no tax will need to be paid on your pension when you die, it can now become an intergenerational planning vehicle. As you enter your 70s, from an estate planning perspective, your pension becomes the last thing you should spend.
The most significant consequences of these reforms are for individuals. But what do they mean for small businesses and their owners?
First, as an employer, and alongside the extension of auto-enrolment to smaller companies this year, you have a chance to empower your staff to take control of their pensions, and to support them in saving prudently. Business owners will be wary of helping employees find professional advice, but if they run an employer-sponsored scheme, they may be able to help employees access guidance.
Second, when the owner of a company is looking to re-invest the proceeds of the sale of part or all of their business, the new flexibilities and the end of the tax on inheritance may make pensions a more attractive place to put money. The amount that you can contribute into a pension each year has fallen to £40,000, however (although you can carry forward unused relief from the previous three years), so you are limited in the amount you can put in.
But not all the recent changes have been positive. In the Budget last month, the chancellor announced that the pensions lifetime limit (the amount that you can have in your pot tax-free across your life) will fall to £1m in April 2016. This is disappointing news. It’s a tax on saving and aspiration, and punishes those with investments that have performed successfully. In the past, small owner-managed businesses might have bought their offices or premises via their pension. The lower limit is going to stifle such innovation.
Given this new, lower lifetime limit, it is important that business owners don’t put all their eggs in one tax-advantaged basket. The amount of money you can put into an Isa each year is rising (some will have been able to contribute over £60,000 in April), and that vehicle is also becoming more flexible. We could soon feasibly see more Isa millionaires than pension millionaires. Venture capital trusts (VCTs) are also attractive.
Business owners would be wise to secure new income streams to replace the money they will forgo when they step down from their company. While the pension reforms are certainly positive, it’s important that they look to the full range of tax planning vehicles to achieve the best retirement.
Chris Aitken is head of financial planning at Investec Wealth & Investment. Please be advised that this material should not be relied upon in substitution for the exercise of independent judgement or seeking independent advice.