Pensions Freedom – the new rules

What is it?

On 6th April 2015, the once-in-a-lifetime dramatic change to private pensions kicked in.  The new pension legislation announced in the 2014 Budget (dubbed “freedom and choice”) introduced new ways on how you can use your pension savings.

In short, the rules were simplified to allow people unrestricted access to their private pensions, hence the term “Pensions Freedom” – previously this was a privilege for the wealthy only.

Taking an extreme example, it means anyone currently 55 and over (due to change to less than 10 years before State Pension Age)  can take the whole amount as a lump sum, paying no tax on the first 25% and the rest taxed as if it were a salary at their income tax rate.   Clearly this would result in a fair bit of tax to pay for the average person!

Flexi-Access Drawdown

Another option available is to simply take the 25% tax-free cash, leave the remaining pension invested for growth and drawing income as and when you need it – this is called “Flexi-Access Drawdown”.

For example, it’s now more common for people to have other sources of income in retirement (such as rental income, working just one of two days a week, taking up a contracting role), so you may only need a small amount of income from your pension in the early years of “retirement” to supplement your other income.

This way you can also limit the amount of tax you have to pay, and goes to show how much income flexibility you can have with the new legislations.

Should I take my whole pension pot as soon as I can?

Typically no, as this would not be wise retirement planning or tax-efficient.  If you wish to have a comfortable lifestyle and not worry about paying essential bills in your later years, you need to draw a level of income that is sustainable.  Also, remember only the first 25% of your lump sum is tax-free and the rest is taxed as if they were earned income for the tax-year.  So this means as high as 45p tax for each £1 (additional tax bracket) could be paid.

According to latest figures from the Office for National Statistics (ONS), in England, men aged 65 years old could expect to live to around 84, while women at this age could expect to reach her 86th birthday.  i.e. this is between 19 to 21 additional years after a typical retirement age of 65, so this the same time frame you must plan for when drawing income from your pension pot.

OK, so what are my options if I am approaching or at retirement?

Because of the new pensions freedom rules, retirees have a lot of flexibility in how they wish to draw their pension pot.  It’s impossible to cover every option and all the technical details and taxation for each one, so we’ll simply cover off the  most common options  below.  Some of these can be combined together.

Option #1 – “Steady Eddy” – Take 25% tax free from your pension pot, then buy a guaranteed income for life (i.e. an “annuity”). This is by far the lowest risk option as you have a secure income  for the rest of your life, but because of this, the income can typically be lower than the other two options.  Smokers or people with health ailments, such as raised cholesterol & blood pressure, can typically qualify for an uplift in guaranteed income, which can be as high as 30% more than a standard annuity.

Option #2 – “Flexi-Access Drawdown” – as mentioned above, this option allows you to take 25% tax-free lump sum, while leaving the rest invested in a flexible income drawdown product for growth and drawing income when needed.  This option is riskier as the income is not guaranteed and there is always the risk that a high level of income drawn can be unsustainable (i.e. you may run out of money!).

Option #3 – “Status quo” – Leave your whole pension pot invested for when you need to draw some income.  This option effectively a series of option #2; every time you withdraw cash from your pension fund, 25% is tax-free and the remaining is taxed as income.  E.g. if you had £100,000 in your pension and took £40,000 out you’d get £10,000 of it tax-free, the rest would be taxed as if you earned more income that year.

What if I’m some way from retirement?

• Why should I bother with all this complicated pension stuff? 

The key benefit of pensions is  that people can effectively save in it from their pre-tax income.  In other words, for a higher-rate taxpayer to save £1,000, they only need to save £600! It can also be used to reduce corporation tax for company directors so it’s important  to review how much you should be saving into your pension to have the retirement lifestyle you want.

People often unfairly dismiss pensions they are “rubbish” and have “poor returns”. Yet what’s funny is that a pension is just a tax wrapper used to protect money from the taxman – it doesn’t “perform” on its own.  It’s the investments inside the pension (investment funds, with-profit funds etc.) that performs well or poorly, which is why they need to be reviewed regularly.

To use an analogy, a pension is a bit like a crisp packet used to protect the crisps.  Blaming the pension wrapper is a bit like saying the crisp packet is rubbish because the flavour of the crisps taste poor.

• Should I transfer my old pension benefits?

This could be a final opportunity to move some old benefits to gain the new flexibility as not all providers allow it, but given the long-term impact pensions can have, we recommend that you seek independent financial advice if the sum of your pension pots exceed £30,000.

How we can help

As professional Independent Financial Advisers, we understand the complexities of retirement planning and tailor our advice to your particular situation.  We offer regulated individual financial advice, not mere “guidance” you receive via call centres.

We can help you by:

• Using plain, non-jargon language to explain the new retirement options open to you and how they can be used.
• Ensuring you take money tax-efficiently from your pensions, draw a sustainable level of income and not make any big mistakes.
• Reviewing your current investment strategies in the light of any revised plans for how you wish take your retirement income.
• Analysing and reviewing your pension transfer options.
• Keep you updated on relevant pension changes that affect you.

Please feel free to contact us today for a friendly, no-obligations chat about your circumstances and how we can help you.

Please note that the information provided here does not constitute financial advice.  Tax rules and reliefs can change in future. The value of investments and income from them can go down as well as up and you may not get back the original amount invested.