“Pension Freedoms” were seminal changes made to the UK pension rules in 2015. The purpose of these changes was to make accessing a personal pension a lot more flexible in terms of how and when the funds inside pension pots were accessed.
Before these changes were introduced there was little choice in what could be done at retirement. At a certain date retirement started and you started drawing your pension, with how much you could receive as your pension income based on annuity rates. Now there are a range of options, including the option to draw a pension whilst continuing to work, taking out your entire pension as cash, taking out a cash free lump sum, or leaving your entire pension pot to your family (tax free).
These new rules apply only to ‘Defined Contribution’ or ‘Money Purchase’ pensions (which can also be known as Personal Pensions and Stakeholder Pensions) which is where contributions over your working life are accumulated into a pension pot. The new Pension Freedom rules do not apply to ‘Defined Benefit’ pensions. These work in a different way, with the amount of pension income you receive linked to your salary and length of service.
Pension Freedoms gave UK retirees a lot more control over their retirement and created many opportunities to maximise a pension pot, especially with careful planning and a good understanding of the rules. We’ll help you understand the rules and the options you have with the new pension freedom rules.
Pension Freedoms now mean you can take your pension pot as cash, either in one go or as a series of lump sums. 25% of the cash taken out will be tax-free, but the remaining 75% will be subject to income tax at whatever your marginal rate is at the time. This means that if you take your pension income in the same tax year as you have other taxable income (such as a salary, bonus, or other income) then you may be pushed into a higher income tax bracket resulting in a higher tax rate.
There is the potential option to withdraw all of your pension pot in one go. However, this option has serious drawbacks, as clearly you won’t be able to take any income from your pension (as you’ve withdrawn all the money) and you may also receive a significant tax bill.
It’s important to decide when and how to take cash out of your pension as the tax you pay can vary considerably (for the same amount of withdrawal). If you want to use your pension pot to pay off a mortgage or clear debts, you should seek financial advice on pension planning. A Financial Adviser will help you find the best solution for your circumstances.
It’s now possible to move your pension pot into a product called a “Drawdown Pension”. This lets you take an income from your pension pot whilst it remains invested (and so hopefully continues to grow). Whilst the income isn’t guaranteed, as it depends on what’s left in your pension pot, there are no limits on the amount you can take as income from your invested funds. Drawdown income is subject to income tax.
This replaced the old system of “Capped drawdown“, which used to be a way of taking an income from your pension pot whilst keeping the money in your pot invested. However, there were strict (and complicated) rules in place to determine how much you could withdraw each year (the “capped” part of the name) with the amount you could take out based on the prevailing annuity rates. Capped Drawdown is no longer available, but if you’re already in Capped Drawdown, you can continue to use it.
The danger with the new flexible drawdown schemes is that your retirement income could fall or even run out if you take too much too soon and start using up the money you originally invested to produce the income – with the added risk of potential stock markets falls.
Although Pension Freedoms means you can currently access your pension from 55, you don’t have to. Choosing when to draw out of your pension means you can leave your pension pot invested as you are no longer forced to convert into an annuity.
You do not need to draw all of your pension out at once, you may choose to withdraw a portion and keep the remainder invested. Leaving all or part of your pension invested and continuing to grow can provide you with more retirement income once you are ready to take your pension.
Obtaining professional financial advice will ensure that you have your pension invested effectively to help make sure you get the most out of your retirement.
Along with the introduction of Pension Freedoms was the ability to access your private pension from the age of 55 and continue to contribute to a private pension until you are 75.
Back in 2014 the UK Government indicated that the age at which people could access their private pension would begin to rise. There was uncertainty as to what the change would be and whether the change would actually happen, as the government did not reveal any actual legislation for the change.
However, in 2020 the Government confirmed they were going to increase the age and so from 2028 you will need to be 57 years old before you can access your private pension. This means that anyone who won’t reach 55 by 2028 will have to wait an extra 2 years to access their private pension pot.
Why the increase? The first reason is a technical one, the age at which you can access your private pension is set at 10 years below that of the State Pension Age (SPA) and this is rising from 65 to 67 in 2028. The reason for the increase in the SPA and the private pension age is that we are living longer and this change reflects that. The Government say they are hoping to “encourage individuals to stay in work whilst helping to ensure pension savings are adequate for later life”.
Longer life expectancy essentially means that you’re going to need your pension pot to last for longer once you reach retirement. The longer you can put off accessing the funds in your pension pot, the better chance you have of living the long and comfortable retirement you had planned.
When you reach age 55, you can access your pension pot and use your retirement savings to buy a guaranteed income, called an annuity.
An annuity is a regular secure income that can last for the rest of your life. You can choose to add extra features, such as yearly increases to your income, or make sure your income can be passed on when you die. Once your secure income is set up you won’t be able to add extra features or cash in your plan.
The income you receive from the annuity will depend partly on how much you have in pension savings to buy an annuity, as well as some other factors, such as your health and the annuity rates at the time.
If you do choose to buy an annuity, you can choose how much of your pension pot you want to convert into an annuity and you can also take up to 25% as a tax-free lump sum.
You can find out more about annuities and see if they are right for you in our article on annuities.
Pension freedoms apply to ‘Defined Contribution’ pension’ pots only. They do not apply to any ‘Defined Benefit’ pension pots (often called ‘final salary’ schemes).
If you have a private sector Defined Benefit pension or one from a funded public sector scheme (most public sector schemes are unfortunately not funded), then you can transfer to a Defined Contribution pension. As long as you are not already drawing your pension.
Transferring to a Defined Contribution pension may seem an attractive option as the pension pot can be accessed from age 55 and the new pensions freedom rules mean there is a lot more flexibility with how and when you take your pension. However, there is a good chance that you will be worse off if you transfer out of a Defined Benefit scheme, even if your employer gives you an incentive to do so, as you will be giving up valuable guarantees. If you are thinking about this, please seek advice from a regulated financial adviser. If the pot value is over £30,000, this is then compulsory.
You can find out more in our article discussing if you have a Defined Benefit/Final Salary pension or not.
In 2015 Pension Freedoms fundamentally changed how you could take your pensions. The new rules now allow much more flexibility and freedom over how you can take your pension, with more chance for a solution that better suits your situation.
With greater pension freedom, though, comes greater responsibility. With many pensions, you are now responsible for making your money last for the whole of your retirement. If you’ve saved into a defined contribution pension scheme, whether through your workplace or a private pension, during your working life, you’ll eventually need to decide what to do with the money you’ve saved towards your pension when you retire, or at age 55 (soon to rise to 57), if sooner.
The money you’ve saved over the course of your life may need to last for the whole of your retirement. You should think and plan carefully around how much money you take from your pension savings and how long it might need to last.
Please get in touch if you have any questions on pensions or any other aspect of financial advice. We are Independent Financial Advisors, based in Bristol, and are always happy to help.
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