Some big changes to UK pensions came into effect in April 2015. You now have a lot more freedom with what you can do with your pension savings. But there are also risks. Here we take a look at the new rules and what it might mean for you.
Traditionally, people use the pension pot they’ve built up during their working life to buy an annuity –insurance product that gives you a guaranteed income for the rest of your life. One of the problems with annuities is that, when you die, anything left in your pension pot will go to the annuity provider. Some may offer guarantees that your next of kin receives a lump sum, but . A lot of people think this is unfair.
The new rules give people a lot more control and choice over what happens to their money, not only during their lifetime, but also after their death if they want to pass on some of their savings to family.
Key facts you need to be aware of:
1. The new rules won’t apply to everyone
The new rules apply to defined contribution (DC) pension schemes, not defined benefit (DB) schemes (also known as “final salary” schemes). It may be possible to transfer a DB pension into a DC scheme to take advantage of the new rules, but you’d need to seek financial advice before doing so, as you may also lose other benefits attached to your pension. Find out more about the different types of pensions.
2. You can still take 25% as a tax free lump sum
This bit doesn’t change. You can still take 25% of the pension pot you’ve built up tax free. You can either do this by taking it all at once, or you can make a number of withdrawals, from which you will get 25% of each withdrawal tax-free.
3. The rest of your pension is subject to income tax
Any other income that you draw from your pension pot will be subject to normal income tax rates along with the rest of your earnings. Your rate of tax will take into account any income you receive, whether that’s from your pension, employment income, or income from any other means such as property. If you chose to take your whole pension pot in cash, 75% of its value would be taxable.
4. The lifetime allowance is being reduced to £1 million
The total lifetime allowance for pensions will be going down from £1.25m to £1m in April 2016. This means that anything you have above £1m in a pension will be subject to tax of 55% when you take it out.
This isn’t good news for diligent early savers. If you’ve started your pension in your 20s or 30s and invested sensibly throughout your career then you’ll have a reasonable chance of hitting this limit. This could also affect people whose parents invested in a pension on their behalf when they were young, as the investment will have had time to grow.
A pension pot of £1m might sound like a lot but if you start young and benefit from decent investment returns you’ll stand a good chance of hitting that amount. Our pension calculator will show you how much you need to now to get to £1m.
5. Annuities for cash
Initially, people who have brought an annuity will not be able to take advantage of the new pension freedoms. However, the Government has announced that this will be possible from April 2016 though the detail is still to be finalised. If you’re thinking about selling your annuity it’s important to make sure you know all the facts. You may not get back quite what you were expecting so it’s key to do the research before committing to anything.
What we think of it all
There’s been a lot of speculation in the media about these changes and some are concerned that allowing pensioners to withdraw all of their pension cash could lead to unwise spending, increasing the burden on the state to support them in later life.
At Nutmeg, we think that giving people full control over what happens to their money is a good thing, but they need the tools and support to help them take on this responsibility. We also believe that people should get into the habit of investing long before they start thinking about what to do with their pension. Leaving your pension invested and taking, money as a regular income through drawdown as and when, you may need, be the best way to make the most of your savings, as you will continue to benefit from any growth in the portfolio, which you would lose by withdrawing all of the funds.
VIDEO: Pension basics
Risk warning
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. A pension may not be right for everyone and tax rules may change in the future. If you are unsure if a pension is right for you, please seek financial advice.
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Kayla Kerr
Kayla Kerr writes on a variety of financial and lifestyle topics for Nutmegonomics. Kayla can be found on twitter @kaylasiobhan.Other posts by Kayla Kerr