Pension freedoms give savers six options for taking their retirement cash such as taking 100% out, annuity as well as other options.
The rules fundamentally changed the way you could cash in from your pension.
To make the best of pension freedoms, you need to understand your options and how the rules work before you take all your money.
Chancellor George Osborne tore the retirement rule book and started with pension freedoms on April 6, 2015.
He aimed to scrap stifling rules that left some struggling to make ends meet even though they had tens of thousands of pounds locked away in a pension.
What Are Your Retirement Pension Freedoms?
Financial experts shroud pension freedoms in jargon, like flumps and benefit crystallisation events, but you don’t need to know this stuff to make sensible decisions about cashing in your money.
Pension freedoms boil down to a few simple options:
| Freedom | One-off income | Regular income | Guaranteed income | Can you run out of cash? |
| Buy an annuity | No | Yes | Yes | No |
| Flexible drawdown | No | Yes | No | Yes |
| Cash in the whole fund | Yes | No | No | Yes |
| Take cash when you want | No | Yes | No | Yes |
Don’t forget that you:
- Can’t take any cash until you are 55 years old
- Still get 25 per cent of your fund tax-free whichever option you choose
- Can pick-and-mix your pension freedoms, for example, cashing in part of your savings and taking the rest as a regular income
- The freedoms apply to ‘defined contribution’ pensions, such as personal pensions, workplace pensions, and the Qualifying Recognised Overseas Pension Scheme (QROPS). Not all workplace schemes or QROPS offer the full range of options
Buying an Annuity
Before pension freedoms, most savers invested in an annuity to give an income during retirement.
Annuities offer a guaranteed income that increases with the cost of living for life but is considered expensive.
Since the advent of pension freedoms, savers have spurned the annuity market, with many preferring to manage their own money.
You never run out of money with an annuity, as monthly income comes with a lifetime guarantee.
Drawing Down Your Pension
Drawing down a pension has become the most popular way to manage retirement money.
With drawdown, the pension fund stays invested in the stock market and continues to grow.
But savers can draw cash out as they wish. That includes regular payments each month or one-off cash withdrawals to fund a holiday or new car.
Pension drawdown suits savers with other sources of income but who need the flexibility to take different amounts of cash when they want.
Cashing in Your Pension in One Go
Pension freedoms let you take all your savings in one go but think about the tax implications before you do.
The first 25 percent of the fund comes tax-free. After that, the pension fund balance is added to your other income and taxed at your highest rate.
Flexible drawdown can considerably lessen the cash you receive. Instead, think about spreading the drawdowns across more than one tax year.
Taking Regular Lump Sums
Pension savers can take lump sums in two ways:
- Payments at regular intervals, like £500 on the first day of the month
- Irregular payments, like £500 on January 1 and £650 on July 1
You can dip into the fund when you need the money. Each withdrawal is 25 per cent tax-free, but the remaining balance is taxed at your standard tax rate.
Tax Dilemma For Retirement Savers
HMRC taxes pension withdrawals as payroll. The problem is if you take £15,000 from a pension, tax rules consider this as an annual payment of £120,000 and will tax all the money less the tax-free 25 per cent lump sum.
Some people massively overpay tax because of the way HMRC treats pension withdrawals.
You can reclaim the overpayment, but the process takes a month or so and sometimes, retirement savers must take more money than they need to account for tax.
What Happens To My Pension When I Die?
When you die, what happens to the money you have not spent depends on your age and the type of pension you have.
- If you have a defined contribution pension with an investment value reflecting how the stock market rises and falls, you can leave the unspent fund to your family or friends. If you are under 75 years old when you die, they inherit the fund tax-free, but if you are older than 75, they must pay income tax on their inheritance.
- If you have a joint-life annuity, your partner can continue to receive monthly payments, but the payments stop if the annuity was on your life alone.
- If you have a final salary workplace pension, you do not have a pot to pass on. However, some workplace schemes pay a pension to the surviving spouse.
Contributing to a Pension in Drawdown
Once you have started to draw down some cash from a pension, the Money Purchase Annual Allowance (MPAA) comes into play.
The MPAA limits the amount you can pay into a pension to £4,000 in a tax year from April 6, 2017.
If you want the full tax benefits of a pension, you must not save more than the lifetime allowance.
The current lifetime allowance is £1,073,100 frozen until at least 2025.
Any pension savings over the lifetime allowance level are taxed.
Pension Freedom Age Changes
The age retirement savers can access their pension cash is going up by two years, a minister has warned.
From 2028, the age limit will rise from 55 to 57 years old as the law changes ‘in due course’.
Raising the pension freedom age was first signalled in 2014, but no legislation has been forthcoming, leaving many to wonder if the change would go ahead.
Who is Affected by Raising the Pension Freedom Age?
Any hike in the pension freedom age to 57 in 2028 affects anyone with a defined contribution personal pension born after January 1, 1971.
Those most at risk from the financial consequences are those born in the early part of the year who may have to delay their retirement plans for two years or more.
Media reports suggest that raising the age limit follows lobbying from the Association of British Insurers, a trade body for the pension industry, who fear the current limit is too low and savers risk emptying their pension pots too quickly as longevity increases.
A Treasury spokesperson said: “The announcement of the minimum pension age rise to age 57 in 2014 set out the timetable for this change well in advance to enable people to make financial plans, and we will announce the next steps in due course.”
Conclusion
If you do have a pension and are coming into retirement it would be wise to seek a qualified pension expert to look at your options as ultimately there is no right option.
What will be feasible will depend on your specific situation. If your pension is over £30k you will need to get financial advice in line with regulations, however, this article it looking at specifically how to take a pension.
With many ways to take a pension, it’s best to look at your current situation and decide what you need to live which should lead to how you need to take your pension.
If you have any questions, please let me know and email me at info@investmentsforexpats.com
