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Pension Freedom

The government brought in its so-called “pension freedoms” on Easter Monday and whilst they will be an enormous help to many, it is important to remember that there are some negatives as well, such as the possibility of an unexpected tax bill.

So here is my guide to the new pension reforms:

Who will be affected?

Basically anyone with Defined a Contribution scheme (DC), around 4.5 million people and it will also be possible for some people with Defined Benefit (DB) pensions (also known as final salary schemes) to convert them into a DC scheme.

With this type of scheme your monthly pension savings go into a big pot, which will eventually be used to buy an income for your retirement. You can now freely access this pot from the age of 55 (57 from 2028), taking out as much as you like, subject to tax.

What tax is payable on lump sums?

Everyone is entitled to take 25% of their pension pot as a tax-free lump sum, either in one go or a series of smaller amounts, but you will have to pay income tax on any amount you withdraw over and above the 25% tax-free allowance.

If that amount, when added to the rest of your income, exceeds £42,386 (2015-16), you will pay tax at 40% on the balance and if the total exceeds £100,000, you will begin to lose your personal allowance, resulting in an even higher tax charge

What tax is payable on regular income?

Until the rule changes, taking your pension pot as a monthly income was pretty well your only option, and was known as an annuity. However you now have the alternative to leave your pension pot invested and take regular income drawdowns, leaving the capital intact in case you need it in the future.

Either way you would pay tax in the same way as you did when you were working, but anyone with total income below £10,600 in 2015-16 will not pay anything. Also, you do not pay National Insurance on pension income.

What happens to my pension when I die?

Providing you are under 75 when you pass away, the new rules make it possible to pass on your pension pot to your family tax free. However if you’re over 75, your family will have to pay 45% tax, instead of 55% as it was before the new rules.

There is some further good news on the horizon , as from April 2016 the government will reduce this 45% rate to an individual’s income tax marginal rate. So if you only pay tax at 20% and inherit your 80 year-old grandad’s pension then you’ll only pay 20% on your inheritance.

Can I still use my pension pot to buy an annuity?

Yes is the straight answer, but the numbers doing so now are expected are expected to drop significantly.

Whether you buy an annuity or take the more flexible option of income drawdown, this may still be the best option for you, especially if you want certainty of income over a long period.

Can I sell an annuity if I have already bought one?

Last year George Osbourne agreed to a consultation process to see if this was possible and the good news is that from April 2016, you will be able to swap your annuity for a cash lump sum.

However this comes with a slight health warning, as the consultation exercise did question how much demand there will be for second-hand annuities, with many experts predicting that it may prove difficult to get a good price, but only time will tell.

I’m in a Defined Benefit (DB) scheme at work; can this be moved to a DC scheme?

Once again yes is the answer, but only if your employer allows it.

Also remember that DB schemes usually offer inflation proofing, plus the ability to pass some of the income on to a spouse (usually 50%), so a switch may mean that you won’t get the best value.

How much am I now allowed to save in my pension?
Male Pensioner in a grey suit bow tie and hat jumping in the air

“I can now access my pension”

From Easter Monday, the maximum you can save into a pension pot will be £1m, reduced from £1.25m. This figure will rise with inflation from April 2018. The government says the change will only affect wealthy people.

However, anyone in a DB scheme will be treated more generously; as such schemes have a notional capital value, calculated by multiplying the annual income by 20. So if the scheme pays an income of £10,000 a year, the notional value of the pension pot is £200,000. Given that the maximum pot will now be £1m, members of DB schemes can therefore expect annual incomes of up to £50,000.

Are there any changes to the basic state pension?

Yes there are; w.e.f. 6th April 2015 the state pension and pension credits are being abolished, to be replaced with a single-tier state pension. The rate will rise from the current £113 a week to around £155, but the precise amount will be set towards the end of 2015.

However, a significant number of people will not qualify for the full pension, as their schemes were contracted out of the second state pension, and they paid lower National Insurance (NI) contributions as a result. To qualify for the full pension, you will now need 35 years of NI contributions, instead of 30 previously.

If I need more detailed help where can I go?

The Department of Work & Pensions has created a new website at https://www.pensionwise.gov.uk/ it is still in the process of being constructed, but there’s a lot of useful information and guidance there already.

Additionally, anyone aged 55 or above can book a telephone interview with the Pensions Advisory Service, or a face-to-face interview with Citizens Advice, to get targeted advice on your individual circumstances. The number to book is 030 0330 1001.

But remember, whilst the advice is free and generally good quality, they cannot advise on specific pension policies or investments. For this you’ll need to go to an Independent Financial Adviser, who may charge a fee for the advice.

 

If any of you would like more detailed information on any aspect of Pension Freedom, send me an e-mail and I’ll be pleased to advise further.