What’s happening in April?
Pensions are undergoing a major overhaul, with changes taking effect with the new tax year, starting on April 6, 2015.
The main changes affect you if you’ve got a ‘defined contribution’ pension – sometimes referred to as a ‘money purchase’ scheme.
These are workplace (or personal) pensions into which you and your employer, if relevant, make contributions. You also get tax relief from the government.
The amount you get out of the scheme depends on the performance of the underlying investments into which your contributions are made.
If you’ve got a number of pensions after working for several employers during your career, you can amalgamate these into what we’ll call your pension ‘pot’.
You don’t have to combine them in this way, but having a single pot might give you more clout when it comes to buying an annuity (that’s the product that actually pays your pension during retirement – more about that in a bit).
And if you have just the one annuity, it can be easier to keep track of payments and manage your money after you’ve retired.
The other main type of workplace pension scheme is known as a ‘defined benefit’ plan (sometimes called a ‘final salary’ or ‘career average salary’ scheme).
Here the amount you receive as a pension is determined by a formula which takes into account your salary at retirement (or the average over the time you’ve been with the employer), your length of service with that employer, and other provisions within the scheme.
If you’re in a defined benefit scheme and want to take advantage of the changes happening in April, you’ll need to transfer to a defined contribution scheme. But this is something that needs to be done with extreme caution, as the guaranteed benefits available from defined benefit schemes can be very attractive. We’ll cover this in a separate article.
Main changes due in April
- You’ll be able to withdraw as much or little of your pension pot as you want
From April 6, once you reach the age of 55, you can take whatever you like, whenever you like, from your pension pot(s). Previously, you were limited to taking 25% tax-free, with punitive rates of tax applying if you wanted to take more.
- You won’t have to buy an annuity if you don’t want to
The pre-April rules oblige people at the point of retirement to use the bulk of their pension pot to buy an annuity (a financial product that pays an income for life) or to leave it invested and draw an income from the fund.
Post April, you’ll be able to withdraw from your pension whenever you want or need money, although there are tax implications to watch out for in many instances.
Don’t be tempted to splurge though – you’ll need your pension to last throughout your retirement.
- You’ll still be able to take 25% of your pension as a tax-free lump sum
It’s always been possible to take 25% of your accumulated fund as a tax-free lump sum. If you wanted to take more, there was a punitive tax rate of 55% to make you think twice.
This is changing. In future, if you decide to withdraw more of your fund, you’ll be charged your ordinary rate of income tax on the slice above 25%, not 55% as you’d pay now.
For example, if you’ve got a £80,000 pension pot, you could take £20,000 as a tax-free lump sum. If you then took the remaining £60,000, the amount of tax you’d have to pay would depend on any other taxable income and allowances you have in the same tax year.
Clearly, careful calculations – and, probably, professional financial advice – would be needed when deciding how to manage your money.
- If your total pension pots are less than £30,000 these can be paid out as a lump sum
Under interim rules, since March last year you’ve been allowed to take up to £10,000 as a lump sum from any small pension pot you might have. The number of pots you can cash in in this way is now three rather than two, so you can take up to £30,000 in total as a lump sum.
- You won’t have to pay a 55% death tax charge on a pension that is left to you by someone else
If someone dies aged 75 or over and you receive their pension, you’ll only pay tax at your marginal tax rate as you draw money from it. If someone dies under the age of 75, you can take money from the pension without paying any tax.
- You will be given free and impartial guidance on the options available to you
The Treasury has stumped up £20m to ensure you’ll get face-to-face guidance on the options available to you at retirement through its new Pension Wise service.
Don’t confuse this with advice though – it won’t suggest which course of action is best for you. If you want advice on what to do with your pension savings, your best bet is probably to speak to an independent financial advisor.
Your action checklist
Here are some of the things you need to think about in the run up to the introduction of the new pension rules:
- How much retirement income are you likely to need?
Think carefully about how much you can live off when you stop work. Add up your outgoings and work out the minimum income you’ll need. Resist the temptation to take out much more than this or you risk leaving yourself short in years to come.
- Don’t underestimate life expectancy
It’s impossible to predict exactly how long you’re going to live, but it pays to give at least some thought to how many years you might be around for. This will help you assess roughly how long you’ll need to make your pension savings last.
According to the Office for Natinal Statistics, the average life expectancy for those aged 65 is around 21 years for women and 18 years for men – so there’s a good chance your pension savings will have to last you around 20 years.
- Have you checked that your pension scheme is ready for the changes?
If you’re retiring soon after April 2015 and want to withdraw some of your pension straight away, contact your pension provider now to check they are ready for you to do this. Some may not be prepared in time, so you could have to wait a while.
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