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Making sense of the Budget’s pension changes

Changes to the way pensions are taxed will have widespread effectsEveryone knows that the changes in the taxation of pensions announced in the 2014 Budget, and now working their way into law, are going to make a big difference.
But just how will they affect you and what can you do to make sure you are a beneficiary of change and not a victim?
From April 2015, anyone over the age of 55 will be able to choose to take their pension savings as a lump sum and not as income.
So, in theory, you could take all the money you’ve saved and pay off your mortgage, have a huge bank balance or even invest in a Lamborghini.
According to numbers released by the Treasury, this is exactly what the government expects many people to do, which is why it expects to make money out of the changes - taking your money all at once may come with a big tax bill.
You’ll still get your cash, but some or all of it may be charged anything between 20% and 45%, depending on your ‘marginal’ rate of tax.

There are other ways

But you don’t have to be a victim. In fact, if you are a little bit careful, you may be able to make tax savings from the changes. Instead of taking your money all at once, you can time how you take it to pay less tax. By using your pension savings when your other income is low, you may be able to avoid paying your normal rate of tax on some or all of the money you draw against.

Investment considerations

But there is a third way of looking at the Budget changes which may make more sense than either of the first two. It involves thinking about investment – and thinking about it from the government’s point of view.
At present, most private pension savings are used to buy annuities. Annuities insure you against living too long and they do so by typically investing your money in government bonds (lending money to government). Put simply, the shorter your predicted remaining lifespan, the greater your potential annuity income.
Budget changes mean greater freedom with your money
The other main way of investing is through buying shares in companies. The long-term investment of pension funds into shares is what has kept the stock market flourishing since the Second World War, but this source of funding for companies is drying up as company pension schemes stop investing.

The importance of seeking proper pensions advice

There is a final piece of the jigsaw which needs to be put in place. If you take away the default investment (annuities) and don’t help people with the choices they have to make, you risk being seen as a government which is at best irresponsible and, at worst, actually mis-selling pensions.
This explains why the government is putting in place the Guidance Guarantee, offering everyone free face to face guidance on their future choices.
The intention of these sessions, which will be paid for by the financial services sector, is to ensure that people who use the Guidance aren’t victims but beneficiaries of the Budget’s pension changes.
Let’s hope that this strategy works and that people take proper Guidance or pensions advice, make good decisions and make the budget as sensible as it should be!
This article has been commissioned by retiresavvy and any opinions voiced are the author's own.


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