Pension Freedoms – how to handle your pension pot
Deciding what to do with your pension savings is an important step we will all have to take.
Following changes introduced in April 2015, you now have more choice and flexibility than ever before over how and when you can take money from your pension pot. These changes give you freedom over how you can use your pension pot(s) if you’re 55 or over and have a pension based on how much has been paid into your pot (a defined contribution scheme).
WHEN AND HOW YOU USE YOUR PENSION
Whether you plan to retire fully, reduce your hours gradually or to carry on working for longer, you can now tailor when and how you use your pension – and when you stop saving into it – to fit with your particular retirement plans.
Currently, the minimum age you can take any workplace or personal pension is age 55. You need to check with your scheme provider or insurance company to make sure the scheme will allow this. This is proposed to increase to age 57 by 2028.
From 2028 onwards, the proposal will be for the minimum pension age to increase in line with the State Pension age. This means there will be a 10-year gap between when you can take your own pensions and any State Pension you are eligible for.
There’s a lot to consider when working out which option or combination will provide you and any beneficiaries with a reliable and tax-efficient income throughout your retirement. Some of the options are:
Option 1 – Leave your pot untouched
Once you reach the age of 55, you have the right to take as much of your pension fund as you like as cash – but that doesn’t mean that you have to do so.
You may be able to delay taking your pension until a later date and may wish to leave your money where it is so that it still has the potential to grow. Equally, you might just want some time to consider all your options before deciding whether to take cash from your pension fund – and, if so, how much.
Option 2 – Use your pot to buy an annuity (a guaranteed income for life)
You can choose to take up to 25% of your pot as a one-off, tax-free lump sum, then convert the rest into a taxable income for life called an ‘annuity’. There are different lifetime annuity options and features to choose from that affect how much income you would get. You can also choose to provide an income for life for a beneficiary after you die.
Option 3 – Use your pot to provide a flexible retirement income – flexi-access drawdown
With this option, you take up to 25% of the pension pot that is being crystallised as a tax-free lump sum, then re-invest the rest into funds designed to provide you with a taxable income. You set the income you want, though this may be adjusted periodically depending on the performance of your investments (funds can be left alone to accrue if there is no immediate need for income). Unlike with a lifetime annuity, your income isn’t guaranteed for life – so you need to manage your investments carefully.
Option 4 – Take small cash sums from your pot
If you’re not sure how your income needs will change in the future, you may wish to take money from your pension pots as and when you need it and leave the rest untouched. 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.
Option 5 – Take your whole pot as cash
You could close your pension pot and take the whole amount as cash in one go if you wish. Anyone over 55 can take their entire pension fund as cash. The first 25% will be tax-free, and the rest will be taxed at your highest tax rate – by adding it to the rest of your income.
It’s important to remember that if you do take the whole pot as cash, it’s highly likely that you’ll have a hefty tax bill and that your pension is to fund your retirement, therefore it’s still important to plan carefully to ensure you don’t run out of money for your retirement.
Whilst there are many options and combination of options that are available, and which of these is most suitable for you depends on your circumstances – it’s important to seek advice from a qualified independent financial adviser who’ll be able to take into account your circumstances.
This article is for general guidance only. It provides an outline, and may not include points which are important to your situation. You should not depend on this blog without taking advice based on the full facts of your case. The information given was correct at the time of publication.
The information was correct at time of publishing but may now be out of date.