It's official – the pension freedoms are finally with us! First announced in the 2014 Budget, the reforms give more flexibility in how you spend your pension pot than ever before, and that means it's vital you understand the new options open to you. But just what do the changes mean? Read on to find the six key things you need to know about the freedoms and what they mean for you.
As of yesterday – 'pension freedom day' as it's becoming known – those aged 55 and over with a defined contribution pension can access their savings as they wish. You're in complete control of how you spend your cash, with prohibitive tax charges reduced and income drawdown limits similarly amended. You can still take the first 25% as a tax-free lump sum, but the rules surrounding what you do with the rest have been relaxed.
The previous system meant that the majority of pension savers had no option but to purchase an annuity when the time came, either because of the tax charges associated with withdrawal or the fact that their income was too low to consider drawdown. Thanks to the changes, you're no longer obliged to opt for annuities unless you want to (remember that an annuity is still the only option that will guarantee you an income for the rest of your life). There are even plans afoot to give those already locked into an annuity contract the chance to sell the income they receive, but this is still in the proposal stage.
Income drawdown is a way to take a regular income from your pot while keeping the rest invested, and the changes mean more people can take advantage of this option: the amount of guaranteed income you'll need to access flexible drawdown (where you're allowed to take as much as you like from your pot) has been reduced from £20,000 to £12,000, and capped drawdown limits have also been changed, with the maximum amount you can withdraw from your pot each year now standing at 150% of an equivalent annuity (up from the previous limit of 120%).
A further form of drawdown has also come to pass – known as 'Uncrystallised Fund Pension Lump Sums' (UFPLS), it allows you to take regular payments from your pension fund. You can take cash directly from your pot and essentially use it like a bank account, with the first 25% of each payment being tax-free and the rest being taxed as income.
Everyone still has the chance to access the first 25% of their pot tax-free, but the tax charges associated with taking more than that have been reduced. You are now free to withdraw the rest of it in one go and will be taxed at your nominal income rate (20% for a basic rate taxpayer, 40% for a higher rate and 45% for an additional rate taxpayer), rather than at the previous level of 55%.
While the new freedoms offer more flexibility, they also pose more risks. You can read more about them here, but one thing you need to be particularly vigilant about is pension scams. Anyone who contacts you regarding ways to re-invest your pension savings should be regarded with extreme caution, and if in doubt, contact the industry regulator to make sure the firm in question is legitimate. Read more about the risk of pension scams and who to contact here.
If you're approaching retirement age, you'll want to get all the support you can when deciding how to spend your pension pot. It'll affect how you secure an income for the rest of your life so it's vital you understand the options, and luckily the Government has stepped in to help. Pension Wise is a free, impartial guidance service that can give you information about turning your pension pot into an income, giving you a thorough grounding in the options available. It'll also point you in the direction of professional, independent advice, something that should always be sought to ensure you make the decision that's right for you.
So, there you have it! The key points you need to know about the pension freedoms. Of course, there's far more to it than can be covered here, so make sure you read our guides for more information and contact Pension Wise when the time comes. One final point to bear in mind – you don't have to decide right now!
Knowing how you'll secure a retirement income is a huge decision and the pension industry itself is still adjusting to the new landscape – new products could become available and your thoughts may change in the months to come, so if you don't have to make a decision just yet, don't feel that you have to rush in. Make sure you get all the information you need, and then you can use the pension freedoms to your advantage to secure the retirement income that's right for you.
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Disclaimer: Information is correct as of the date of publication (shown at the top of this article). Any products featured may be withdrawn by their provider or changed at any time.
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