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The evolution of pensions

Miles Clarke, Chartered Financial Planner
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Pensions in one form or another have been around for hundreds of years. The earliest is said to date back to Roman times when an income would be paid to centurions when they ceased service. In the UK, as early as the seventeenth century, the Royal Navy introduced a pension scheme for officers but over the past century pensions have really gathered pace to what now is an incredibly complex and detailed area.

The introduction of the UK workplace pension

UK workplace pensions began to emerge in the last quarter of the nineteenth century and were introduced for nurses, teachers, civil servants and the police. The private sector was quick to follow. In 1908, the first "old age" pension was introduced by David Lloyd George and the modern State Pension arrived in 1948, payable from the age of 65 for men and 60 for women.

The Finance Acts of 1921 and 1947 introduced tax relief on pension contributions together with rules relating to restricting the amount of tax-free cash entitlement to 25% of the pension fund size. During the following quarter of a century, company pensions really took off and strong stock market returns saw the value of these pension funds soar.

In 1988, the Thatcher government introduced widespread pension reform. Individuals were encouraged to invest into private pensions and were given the right to not join their employer's scheme. At the same time, the option to ‘contract out’ into a private pension was introduced.

Since then there have been many types of private pensions including:

  • Retirement Annuities Contracts
  • Personal Pensions
  • Money Purchase Schemes
  • Group PPP
  • S32 Buyout Policies
  • Stakeholder Pensions
  • SIPPs

Pension simplification – or not?

In 2006 pension simplification, otherwise known as ‘A-day’, introduced significant changes to both personal and workplace pensions. Before A-Day, pensions had been governed by eight distinct tax regimes, introduced over many years, but now all would be governed by one set of rules. These new rules altered how benefits could be taken, at what age, what funds may invest into, how much could be contributed and a cap on the size to which a person’s fund could grow. The aim of the rules was to make pensions more straightforward but, in reality, it did anything but.

A-day introduced the Annual Allowance for pension contributions and the Annual Allowance tax charge at 40% for those who exceed it. The Annual Allowance for the tax year 2007/2008 was set at £225,000, a figure which increased by £10,000 each year to 2010/2011 (peaking at £255,000). This was subsequently slashed to £50,000 in 2011 and then further reduced to £40,000 from 2014. Many complexities have arisen in relation to the Annual Allowance such as pension input periods, the Money Purchase Annual Allowance, carry forward and Annual Allowance tapering to name but a few.

Additionally, a new Lifetime Allowance capped the total value of individual’s pension funds at £1.5 million from April 2006, rising to £1.8 million by 2011. Anything above this limit, when taking benefits, incurs a harsh tax charge of 55% if taken as a lump sum. We have since seen the Lifetime Allowance fall in 2012 to £1.5 million, then in 2014 to £1.25 million and finally in 2016 to £1 million, with a host of protections on offer (primary, enhanced and multiple fixed protections) to apply for along the way.

Up to the 5 April 2010, the earliest age at which benefits could be taken was 50 but this also changed on 6 April 2010, increasing to age 55.

Radical changes to private pensions in the 2015 Budget

The Chancellor, George Osborne, announced in the 2015 Budget 'freedom and choice in pensions' and declared "no one will have to buy an annuity". This brought about many more options and welcome flexibility for those well advised although, for others, the opportunity to make significant mistakes. It was announced that the Lifetime Allowance, then set at just £1 million, would increase annually with inflation and at present is £1,055,000. In addition, a sliding scale Annual Allowance was introduced, tapering down from the £40,000 limit to £10,000 per year for the highest earners.

At the same time, George Osborne linked the state pension age to rising longevity, implying younger generations will have to work until they are 70 to get a state pension. This runs alongside Auto Enrolment which has been phased in from 2012 to 2017 and requires employers to enrol employees into a company pension.

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The future

When approaching retirement today, individuals have more choice than ever in terms of when and how they draw their benefits and what death benefits are available too. With this choice comes the need to consider all options carefully and decide which approach works best. There is unquestionable benefit to pension flexibility, yet many rules and tax changes can be to the detriment of certain individuals.

The evolution of legislation over the past 100 years has left us with a highly complicated set of rules and regulations governing pensions. Specialist advice is required to understand the interaction between state, occupational and private pension plans and no doubt further changes won’t be too far away!

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Phil Smithyes
Phil Smithyes
Partner, Head of Financial Planning
Thames Valley