Budget 2014: huge revolution in Isas and pensions

George Osborne surprised just about everyone today with some very substantial changes to the pension and Isa regime.

Let’s start with Isas.  The current annual limit is £11,520, only £5,760 of which can be saved into a cash Isa.  At the moment, you can never transfer money from a stocks and shares Isa to a cash Isa.

The chancellor is now increasing the overall limit to £15,000, and it can all be saved as cash, if that’s what you want. You can move your money back and forth between cash and shares as much as you like.

The new rules also apply to existing Isas, so we could see some investors moving money from shares to cash.

This is an exciting move. It will now be easier to build a sizeable Isa savings pot. Some people may decide that they no longer need to save any money into a pension. The Isa allowance could now be large enough for their savings needs.

Pensions will become more attractive

However, thanks to other changes today, pensions are now a more attractive savings vehicle as well.

Today’s pension changes are all aimed at defined contribution pensions – the pensions where employees, and normally their employers, save money into a pension pot. That pot is then used to generate an income when the employee retires – normally via an annuity.

The problem with defined contribution pensions has been that many retirees have been disappointed by the annuity rates they’ve been receiving. That’s partly been due to falling gilt yields as annuity rates move in line with gilts.

But, on top of that, many retirees have been ripped off by their pension providers and given a rotten rate. These retirees would probably have done better if they had shopped around between different annuity providers, or if they had considered the alternative of income drawdown.

So I’m very pleased that the Chancellor wants to create a ‘right to advice’ so that everyone can get free advice when they’re deciding what to do with their pension pot.  Hopefully, all new retirees will get the best possible deal as a result.

Lump sum withdrawals will become more flexible

I’m also pleased that the rules on withdrawing money from your pots are set to become more flexible too.

Currently, you can withdraw 25% of your pension pot as a tax-free lump sum when you start to take a pension income. If you want to take a larger lump sum, you currently have to pay 55% tax on the excess above the 25% band.

Under the new plan, you’ll only have to pay your marginal income tax rate on the excess. For many people, that will only be 20%.

I’m sure that many new retirees will now be tempted to take out more than 25% from their pension pot, so this could create a nice tax windfall for the government.

The allowance for ‘trivial commutation’ is also going to rise. Currently, if your pot is £18,000 or less, you can take it all out in one go. That allowance is going up to £30,000.

However, don’t rush to withdraw all of your money just yet. All of the pension changes I’ve described so far will need primary legislation and so probably won’t come in until next year.

Changes to income drawdown coming later this month

However, changes to income drawdown will come in later this month.

Income drawdown is the traditional alternative to annuities and it provides some extra flexibility.

Under the new rules, if you can demonstrate that you have a £12,000 annual income from other pension sources, you’ll be able to take out as much money as you like from your pot via drawdown. This is known as flexible drawdown.

And even if you don’t have that £12,000 income, the amount you can withdraw each year will be increased.  The drawdown limit will rise from 120% of a typical annuity income to 150% of a typical annuity.

Is there a catch?

I worry there is a potential catch to these changes that I haven’t thought of.

But so far, I can only think of one major downside.

That’s the risk that people will spend their savings too quickly and then will be totally reliant on the state to look after them when they’re in their 80s or 90s.

The government may have to spend more on means-tested benefits for older pensioners.

It’s certainly a risk, but my view is that the government is right to give people extra freedom. In broad terms, people should be allowed to spend their money as they see fit. And the combined Isa/pension changes may encourage people to save more. That would be a welcome boost for the economy.

New savings bonds for pensioners

The new pensioner savings bonds from NS&I are also a very welcome move. They’ll be launched next January.

Anyone aged 65 or over will be able to invest up to £10,000 in a bond, and the one-year rate will be in the region of 2.8%. The three-year rate will be around 4%.  These rates are superior to any equivalent savings product on the market right now.


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