George Osborne’s sweeping pension reforms have certainly divided opinion within the investment industry and among the British public. The premise of the new changes is that, from April 2015, those aged 55 or above can choose what they do with their pension.
In the past, you could either withdraw your pension as a phased, capped draw-down, or take the full amount at a punitive 55% rate of tax. This was only really relevant to those with very large savings pots, or to those who hadn’t saved enough to rely upon it in retirement.
For everyone in the middle, the option was to buy an annuity – a kind of insurance product that ensures you receive a regular income for the rest of your life. However, the danger with annuities is that, when you die, your fund will go to the annuity provider. Some may offer guarantees that your next of kin receives a lump sum, but it’s unlikely to be anything like the amount you invested. The new rules give people a lot more autonomy and control over what happens to their money, not only during their lifetime, but also after their death if they choose to pass on some of their savings to family.
There’s been a lot of speculation in the media about these changes, and some are concerned that allowing pensioners to withdraw all of their pension cash could lead to unwise spending, increasing the burden on the state to support them in later life.
At EPP Wealth ltd, we think that giving people full control over what happens to their money is a good thing, but they need the tools and support to help them take on this responsibility. We also believe that people should get into the habit of investing long before they start thinking about what to do with their pension. Leaving your pension invested and taking draw-downs of the money you need may be the best way to make the most of your savings, as you will continue to benefit from any growth in the portfolio, which you would lose by withdrawing all of the funds.
Some of the key facts you need to be aware of:
1. The new rules won’t apply to everyone.
The new rules apply to Defined Contribution (DC) pension schemes, not Defined Benefit (DB) schemes (also known as “final salary” schemes). It is often possible to transfer a DB pension into a DC scheme to take advantage of the new rules; however you’d need to seek financial advice before doing so, as you may also lose other benefits attached to your pension. If you’re already receiving an annuity income, the new rules won’t apply to you.
2. You can still take 25% as a tax free lump sum.
You can either do this by taking 25% of your pension fund tax-free all at once, or you can make a number of withdrawals, from which you will get 25% of each withdrawal tax-free. For example, if you took a withdrawal of £10,000 (assuming that’s not equal to 25% of your fund) you would get £2,500 of that money tax-free.
3. The rest of your pension is subject to income tax.
Any other income that you draw from your pension pot will be subject to normal income tax rates along with the rest of your earnings. Your rate of tax will take into account any income you receive, above your personal allowance of £10,000; whether that’s pension drawdown, employment income, or income from any other means such as property. If you chose to withdraw your whole pension pot in cash, 75% of its value would be taxable. If your pension pot is large enough, this may take you into the higher rate tax bracket, meaning 40% would go straight to the tax man.