In his Budget speech today, chancellor George Osborne promised that ‘no one needs to buy an annuity' as he unveiled a package of reforms that will ultimately mean an end to restrictions on how people withdraw money from their pensions.
Previously, an individual could take 25 per cent of their pension pot as a lump sum, tax free, at the age of 55, but had to pay 55 per cent tax on any further cash withdrawals. This penal tax rate has now been abolished, meaning that any investor who takes more than 25 per cent as a tax-free lump sum will only pay their marginal rate of income tax on the balance. This is 20 per cent at the basic rate, 40 per cent at the higher rate, or 45 per cent for those earning over £150,000.
From April 2015, investors will be able to withdraw cash from their pension as and when they want.
For more information about the new rules and how they will affect your options for drawing an income at retirement, download this free guide.
The chancellor confirmed that in future everyone will be entitled to free advice on their pension options, with £20 million set aside by the government for the purpose.
Laith Khalaf, head of corporate research at Hargreaves Lansdown, said, 'What the government is saying is "it's up to you to decide when you want to take money out", but you will pay tax at your marginal rate on the withdrawals.'
Khalaf added: 'It's a very significant reform, but it's positive. It gives people greater freedom to do what they want with their pension savings and will attract more people to save in pensions, because they are now being treated like adults.'
James Baxter, a partner at Tideway Wealth, commented that the low rates currently available on annuities would mean that in practice, 'most who get the government's free advice will be told not to buy an annuity'.
He believes this will 'end the culture of the annuity as a default option for pension investors'.
In the wake of Osborne's speech, markets anticipated a deadly impact on the annuity market, with sharp falls in the share prices of annuity providers such as Legal and General (down 11 per cent) and Just Retirement (down 42 per cent).
Khalaf acknowledged that 'there were dangers' to allowing pensioners free access to their entire pension pot. But he said that the prospect of paying a higher rate of tax would make it unattractive to withdraw large amounts all in one go.
Changes to drawdown rules
Before all restrictions on withdrawing cash from pensions are removed in April 2015, interim changes are being introduced this month which make the current pension drawdown rules more flexible.
There will be a reduction in the amount of guaranteed income a pensioner needs to enter what is called 'flexible drawdown', which entitles you to withdraw as much as you like from your pension each year, with no restrictions.
The previous £20,000 minimum guaranteed income needed for flexible drawdown is to be reduced to £12,000 from 27 March 2014.
In addition, those with less than £12,000 in guaranteed income will be able to withdraw up to 150 per cent each year of what they could have earned from an annuity, as opposed to the current limit of 120 per cent.
Baxter noted that with the state old age pension currently providing just short of £6,000 a year, pensioners with even a small workplace pension could come close to the new £12,000 income needed to enter flexible drawdown.
He calculated that investors would need a £100,000 pension pot to buy £6,000 of annual income, taking them up to £12,000 guaranteed income including the state pension.
Khalaf said that the pension reforms announced in today's Budget mean that 'drawdown will effectively disappear as we know it' from April 2015. 'What you'll get is a drawdown plan that doesn't put a cap on the withdrawals you can make – in essence, a drawdown plan with no limits,' he added.
Find out which companies are a better investment as a result of these reforms, and which are likely to lose out.