How The New Budget 2014 Pension Rules Work

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Chancellor George Osborne has changed pension rules for defined contribution pensions – but how do the new rules affect retirement savers?

First, the new rules are temporary and will run from March 27, 2014 until April 5, 2015, and by that time Osborne expects to have new laws in place to make the changes permanent.

What is a defined contribution pension?

Defined contribution or DC schemes, as they are called in the industry, are private or workplace pensions without payments linked to a final salary.

Final salary or defined benefit (DB) schemes are mostly public sector pensions and fall outside of the new rules.

Who can draw cash under the new rules?

Mostly retirement savers over 60 – but as young as 55 years old if the rules of the pension scheme allow.

How much can be withdrawn?

Providing a retirement saver has not already taken cash and the pension fund is valued at £30,000 or less, all the money can be taken.

How much tax is paid?

The first 25% is tax-free and the rest is taxed at the retirement saver’s marginal rate, which is the highest amount of tax they pay. For a basic rate taxpayer that is 20% and a higher rate taxpayer, 40%.

So, for someone drawing the £30,000 maximum, the first £7,500 is tax free. A basic rate taxpayer would than pay £4,500 at 20% on the remaining £22,500, leaving them with a lump sum of £25,500 (£18,000 plus £7,500).

What about drawdown?

Drawdown means leaving the pension in place still growing while phasing the payments as and when a retirement saver wants or needs them.

It’s like using a pension as a cash machine, taking out what the saver wants as and when they need the money.

Drawdown can be capped or flexible.

Capped drawdown explained

As the name suggests, retirement savers have a limit on how much they can draw each tax year from their pension.

The limits apply for three years and are recalculated by the Government Actuary Department or GAD.

In Budget 2014, the Chancellor set GAD at 150%, which means retirement savers, can draw £1,500 per £1,000 in the fund.

How flexible drawdown works

To qualify, the retirement saver must prove they have at least £12,000 of income from other sources to pay their bills.

Then, they can draw whatever they like.

Tax on drawdown

The first 25% of the fund is tax-free; the marginal rate tax applies as in the example above.