A number of changes to pensions were announced in the 2014 Budget, intended to make them more flexible and appealing to ordinary investors. So how will the new rules operate in practice when they are introduced in April 2015?
First off, a number of things won’t change. The new legislation only applies to defined contribution pensions, so final salary and career-average pensions will continue to operate as they do today. You will also still be able to make company and personal contributions from pre-tax income, with the pension funds accumulating in a largely tax-free environment.
The key changes relate to your options when you want to access the money you have saved and to the tax treatment of any remaining funds when you die. Here we will focus on the first set of changes, which results in 4 options.
Taking your whole pension pot as a lump sum
If you are over 55 or cannot work because of poor health, you will be able to take your whole pension pot as a lump sum. 25% of this will be tax-free and you’ll pay income tax on the remainder.
Alternatively, you could take 25% of your pension pot as tax-free cash and leave the rest in a drawdown account where it would stay invested. You’ll then be able to withdraw an unlimited amount from this account, either as a regular income or as a series of one-off payments, with these withdrawals being subject to income tax.
Taking ad-hoc lump sums
Instead of taking a one-off tax-free lump sum, you could choose to take ad-hoc lump sums as and when you need them. With each withdrawal, 25% of it will be tax-free and you’ll pay income tax on the rest.
Buying an annuity
Either at the point you retire, or later on, you can still use any pension savings to buy an annuity – an insurance policy that offers a guaranteed lifetime income.
While these changes give greater flexibility when it comes to pensions, the new rules also increase the range of potential outcomes. Some people could receive a higher pension income and pay less tax than under the old legislation. However, the less-informed could miscalculate and find themselves running out of money. Annuities have been less popular in recent years because the rates being offered are lower because interest rates are ultra-low, but the beauty of them is they provide a regular income for life and can, therefore, protect against running out of capital.
There are also changes to the tax-free allowances: once you have used the new pension income freedoms, your tax-advantaged annual contribution limit for defined contribution pensions will drop from £40,000 to just £10,000.
In addition, pension providers are not forced to offer all of these options. If your scheme does not offer the option you require, you could switch to another provider, but you may be charged for doing so.
Both the Citizen’s Advice Bureau and Pensions Advisory Service will offer free guidance on these issues, but it will not be regulated financial advice. So they cannot make any specific recommendations and, importantly, if you do make the wrong choices there will be no legal comeback, either through the courts or the Ombudsman, over the guidance they gave you.
Ian Thomas is authorised and regulated by the FCA. This article is intended to provide helpful information of a general nature and does not constitute financial advice.