As of Monday April 6, anyone aged 55 or over will have enjoy far greater freedom in how they use their pension pots. But with this new liberty comes greater responsibility and risk.
The new rules aim to give people more choice about how they spend the money they have saved up over the course of their working lives and to prevent so many people from being effectively forced into buying an annuity, which in recent years have been felt to provide poor value for money.
The new rules will enable savers to withdraw as much or as little as they like from their pension pots once they have passed their 55th birthday. This means that many people will no longer need to purchase an annuity to provide them with an income in retirement. With the option to leave more of their pension invested for longer, savers will have the ability to let their retirement fund grow.
Breaking up lump sums
It will soon become much easier for pensioners to take their 25% tax-free lump sum in smaller amounts over time rather than having to take the full amount in one go. Pensioners will have the option to take 25% of each withdrawal tax free, with the remainder taxed at their relevant income tax rate. But big question marks hang over the changes, as many pension providers have struggled to adapt their systems to provide savers with ad hoc access to their funds. Some are also imposing charges every time a saver makes a withdrawal, meaning pensioners may have to transfer to a provider that can offer better accessibility to their savings pot. However, innovation and competition in the retirement income market sector is likely to improve the market in the future.
You need to take into account the tax implications of cashing in your pot – you will be taxed for making withdrawals on all but the first 25% of your total fund. If you take too much in one tax year, you could lose 40% - or even 45% - to the taxman.
The reforms apply to savers with defined contribution (DC) pensions or money-purchase schemes. The changes do not apply to savers who have defined benefit (DB) or final salary pensions, although members of DB schemes can request to be moved into a DC scheme to take advantage of these changes – unless they are members of certain ‘unfunded’ public sector pension schemes, including the civil service, NHS staff, the police and fire-fighters. In any case, doing so would likely mean sacrificing considerable perks like inflation-linked income, while the sum they would receive for the transfer may also be significantly below the value what they would have received if they remained in their original scheme.
The Government has also announced that around five million retirees who have already bought an annuity will be allowed to sell their policies from April 2016, and is consulting with the industry how such a market might work in practice.
Death and taxes
The raft of reforms also includes the scrapping of a deeply unpopular 55% charge that applies to money left over in a pension plan at the saver's death, often called the ‘pensions death tax’. While pensions are not subject to inheritance tax, a pension-holder who dies before the age of 75 can pass on their funds free of tax – provided they are under the lifetime allowance, currently £1.25 million - and it will no longer matter whether any of their pot has already been spent. If they die aged 75 or over, there will be a 45% flat-rate tax charge if taken as a lump sum in this tax year, or taxed at the marginal rate of income tax from next year. Funds can be passed on as income and the beneficiary will be taxed according to their marginal income tax rate when withdrawn.
Many people are poised to take advantage of the raft of changes to pension rules. Research by TD Direct Investing, the broker, reveals that two in five people (40%) of those surveyed plan to withdraw part or all of their pensions once the reforms come in. Yet it found that 46% of respondents over 30 feel they have not had enough guidance to make the best decision on their pension. A worrying 48% of interviewees do not trust the pensions industry. Meanwhile, 50% of respondents are confident that their property will support them in later life.
Jamie Smith Thompson, managing director of Portal Financial, a financial adviser, says: "It is a massive change. I do believe it is a positive step, so I don't want to scaremonger, but if people do not get professional financial advice their decisions could come back to haunt them in later life."
Are you planning on taking advantage of the new pension freedoms? What will you do? Let us know in the comments below.
This article has been commissioned by retiresavvy and any opinions voiced are the author's own.
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