Pension freedoms - 10 ways pensions have changed
14 April 2015
Monday 6th April 2015 will forever be known as Pension Freedom day. Not only the start of a new tax year, significant new pension rules also took effect, described as a “Pensions Revolution” by Chancellor George Osborne.
The new freedoms give investors over the age of 55 unprecedented freedom over how and when they take their pension. It's estimated 540,000 pension savers could benefit from the new rules over the next 12 months. I’m pictured here with Mr Gunn who was the first Hargreaves Lansdown client to take advantage.
10 ways pensions have changed
- Investors now have freedom and choice over how they take money from personal pensions from age 55 (this is likely to change to age 57 from 2028 although not yet in law).
- They can buy a secure income for life via an annuity, draw directly from the fund via drawdown, take periodic lump sums, and now even take the entire amount as cash, choosing to spend, gift or invest, however they wish.
- They can take unlimited income using New Drawdown. This offers up to 25% of the fund as tax free cash, and the ability to draw taxable income, if required, directly from the fund which remains invested for potential growth although fund values can also fall. There are now no limits on how much income can be withdrawn, although care is needed - this is a higher risk option as investors could run out of money if they take too much out, they live longer than expected or the investments perform badly. The pension can be passed on to heirs on death, in some cases tax free. Taxes can change and will depend on the circumstances of the individual investor.
- Pension savers can now also take lump sums directly from their pension, without taking an annuity or moving into drawdown. This is known as an Uncrystallised Funds Pension Lump Sum (UFPLS) and is available to savers from age 55 who have not yet taken tax-free cash or income. Like drawdown, this new option allows you to take lump sums from your pension, which remains invested. However, you don't take the 25% tax-free lump sum up front. Instead, 25% of each amount you take should be tax-free.
- Under the new rules pensions can now be passed on in a tax efficient manner on death. Nominated beneficiaries will be able to inherit pensions, and take the proceeds out free of income tax if the original investor died before the age of 75. If they died after 75, withdrawals will be subject to income tax (up to 45%).
- The punitive 55% tax charge that sometimes used to apply to pension lump sums on death has been scrapped.
- Investors drawing directly from their pension are now restricted on how much they can further pay into pensions – so it can make sense to use allowances before you take benefits.
- Those who were in income drawdown before April 2015 can choose to keep the existing income restrictions, known as a Government Actuary’s Department (GAD) limit, in order to make larger pension contributions in future. Alternatively you have the option of switching to New Drawdown.
- Investors have access to free guidance, via the government's new Pension Wise service. Remember, what you do with your pension is an important decision. Despite the increased flexibility, investors need to remember a pension should last throughout retirement.
- The rules extend to personal pensions, stakeholder pensions, SIPPs (Self-Invested Personal Pensions) and most schemes which build up a fund for retirement. They do not apply to final salary or defined benefit pensions in the same way. The new rules also don’t apply to most pensions in payment such as annuities. However this may change in the future. A further new rule means you may need advice before transferring out of final salary schemes.
To cash in or not to cash in
The immediate interest is in how many pension savers will cash in their pots and what they might spend their money on. First and foremost pension savers need to ensure is that they have sufficient income to live on throughout their retirements, allowing for rising price inflation and contingencies such as long term nursing care, so do you research carefully. There is also lots of free information available here www.hl.co.uk/tools/free-investment-and-pension-guides
Actually some pension providers don’t offer the cash in options yet so some investors might need to transfer to a pension provider which does to take advantage, although you should check you are not giving up valuable benefits or will incur exit penalties before you do so.
It’s important to remember that for most people, pension pots are retirement savings, needed to pay income for what could be a 20 or 30 year retirement or even longer. Add to the mix that 75% of a pension pot is taxable and it makes very little sense to take taxable money out of a pension, pay tax rates up to 60% on this money and then to invest elsewhere.
I expect fewer than 10% of savers to cash everything in – and where they do, smaller pots are likely to be involved. What I do expect is pension savers to continue to take the 25% tax free cash sum - almost every saver already does this at retirement. Using this money to buy a retirement home or perhaps invest for income, are potentially both good uses for this money.
I strongly recommend you understand your options and check they are suitable for your circumstances: take appropriate advice or guidance if you are unsure. Pension Wise, the Government's new pension guidance service, provides a free impartial service to help you understand your options at retirement. It's available at www.pensionwise.gov.uk, by calling 030 0330 1001, or face to face.