The changes to the rules which govern how and when you can take your pension income came into effect in April 2015. Yet despite having a long lead in time before the new rules came into effect, many people are still understandably unclear about the changes and the tax implications of accessing their pension savings.
The new pension rules give more choice as to how you can access your pension savings. And whilst there is a lot of talk of the changes available to retirees at 55, many of us will not have planned to retire at 55, but at 65, 70 or even later. So, whatever you hope to do, whether it is retiring fully or reducing working hours and topping up your income from your pension, and at whatever age post 55, what are the options?
Our guide to your Pension Options
The new pension rules allow you to mix and match any of the options below, using parts of one pension pot or using separate or combined pots. Not all pension providers offer the full range of flexible options and, even if they do, it is still important to work with your financial adviser and allow them to shop around all the reputable providers in order to secure you the best arrangement.
Whilst the options sound straightforward, there is a lot more to consider when it comes to working out what is best for you and your money.
Option one: Do nothing for now
Most pension providers will allow you to take your pension benefits at an earlier, or later date than you originally planned. So, why wait until you are older? If you defer taking your pension until a later date it will remain invested, and whilst invested, any growth will be tax-free . Most people who do this are aiming for their pension fund to continue to grow with the aim of getting a higher income at a later date.
Another good reason is that you can continue making savings into your pension. These will still be eligible for tax relief on pension contributions based on your earnings each year which is capped at £40,000 (tax year 2015-16). Under current legislation these may still be eligible for tax relief until you reach age 75.
If you are considering delaying for only a few years, don’t forget to get advice about how much investment risk you are taking with your funds; you don’t want to risk a substantial loss this close to retirement.
Remember if you want to make changes to your pension, check with your pension scheme or provider as to whether there are any restrictions or charges for changing your retirement date, and the process and deadline for telling them. Also check that you won’t lose any income guarantees by delaying your retirement date.
Option two: Chose a guaranteed income for life with an annuity
It may be that you just want the security of having a guaranteed income for the rest of your life. In which case, you may want to consider buying an annuity.
You can take a quarter of your pension pot (25%) as a one-off, tax-free lump sum. The remainder of the money must be used to buy an annuity which will give you an income until you die. How much of an income you will receive depends on how much you have saved into your pension, your health, the annuity provider, whether or not you want an income that will rise in line with inflation or to provide an income for your spouse after your death. A financial adviser will ensure you choose the right annuity and secure the best income deal for you.
Option three: Choosing a flexible income arrangement or flexi-access drawdown
With this option you take up to 25% of your pension pot as a tax-free lump sum, and the rest is invested in order to provide you with a regular taxable income. With the help of your financial adviser, you set the income level you want. This can be adjusted periodically depending on how your investments perform (which don’t forget can be good or poor) or how your income needs change over time. Unlike with a lifetime annuity, the income isn’t guaranteed for life, so careful management of your investments is essential.
Option four: Withdrawing ad-hoc small cash sums from your pot
You can use your pension pot in a similar way to a savings account, taking cash as and when you need it and leaving the remainder to grow tax-free. For each cash withdrawal the first 25% is tax-free and the rest counts as taxable income. There may be charges each time you make a cash withdrawal and/or limits on how many withdrawals you can make each year.
With this option, your pension pot isn’t re-invested into new funds specifically chosen to pay you a regular income and it won’t provide for a dependent after you die. There are also more tax implications to consider than with the previous two options.
Option five: Withdrawing your entire pension pot as cash
You could close your pension pot and take the whole amount as cash, but there are serious tax implications to consider if you decide to do this. The first 25% will be tax-free and the rest will be taxed at your highest marginal tax rate – by adding it to the rest of your income. For many people this could mean a large proportion of this money is taxed at the higher rate tax band of 40%.
There are many risks associated with cashing in your pension in one lump sum. Without very careful planning, you could run out of money and have nothing to live on in retirement, so it is important to seek good financial advice.
Option six: Mix and matching your options
You can mix and match the pension options, taking cash and income at different times to suit your needs.
There are of course many things to consider in working out what is right for you. Many decisions which are made regarding pensions are irreversible; you may not be able to change your mind at a later date, even if you realise that you have made a mistake, so it is important to give proper time to look at all the options and make sure you understand the implications of each one.
Be prepared to think about a range of factors such as:
The date you plan to stop or reduce your work. If reducing work, is this likely to be a one-off reduction, or a slow ‘phasing’ out of working hours.
- The amount of income you want and your attitude to taking investment risk
- Your age and health
- The size of your pension pot and other savings
- If your circumstances are likely to change in the future
- Whether you have financial dependants
Above all, make sure that the person advising you on your pension is reputable; there is an industry wide concern that people approaching the age of 55 are vulnerable to pension scams which could see you lose your hard-earned savings. Have a look here to make sure you are aware of the warning signs.
If you would like to find out more about your pension options, please say hello, we'd love to help.