Pension Freedom? What they don’t tell you…
It’s all over the news and the pundits either love it or hate it.
Up until now you have generally had two options with your fund at : use it to secure an income for life (the annuity route) or leave it invested and draw an income from it (the drawdown route). Unless you had a historic entitlement to more, your access to a free lump sum had been limited to 25% of your fund value at the date of retirement. The tax free amount isn’t changing, but what you can do with the remainder is.
From 6th April, those over 55 years of age now have total freedom to take control of their retirement savings and do with them what they wish. If you still want to buy an annuity and fix your income for life, you can do. If you want to leave it invested, drawing down on it as required, you can do. Alternatively, if you wish to take it all in one go, you can do.
Furthermore, if you take what you need and leave the rest invested – your beneficiaries will no longer be penalised with a 55% tax charge on your remaining fund when you die. This will be available to them tax free should you die before age 75, or subject to income tax if you die after 75.
Clearly the headline options have some appeal, as pension providers reported record call levels in the week following 6th April, with some waiting times running into hours as opposed to minutes. But before you rush to access your fund, be that to pay off debts, invest or to splurge, make sure you have considered the implications.
This is one of the most complex areas of financial planning that we deal with, so it is not possible to summarise everything here, but the below should give you a flavour of the kinds of factors we need to consider in each and every case.
Available via your current contract?
Are the pensions freedoms available from your current pension contract? Whilst legislation now permits flexi-access drawdown and Uncrystallised Funds Pension Lump Sum (UFPLS), that doesn’t mean that your pension provider has to allow it. Many contracts, particularly older legacy ones, just won’t allow you to make use of the new facilities. Others may allow them, but charge for the privilege. Of course you have the option of moving your fund to a provider that does offer the flexibilities, but there may be costs and other penalties for doing this.
Have you considered the tax implications? Whilst you can generally take 25% of your fund tax free, any further lump sums or income that you take will be subject to income tax at your marginal rate. For example with a £50,000 fund, taken in one go, £12,500 would be tax free and the remaining £37,500 would be subject to tax at your marginal rate. This means that the income is added to your other income for the tax year and taxed at your marginal rate. For a basic rate tax payer it is likely that some of this would be taxable at 20%, with the remainder being taxable at 40%, to the extent it pushes you over the higher rate tax threshold. You may also wish to check how it might affect other means-tested benefits you could be in receipt of. Likewise, don’t forget the tax implications of what you invest in. Anything you invest in outside of your pension will be , even if you just leave it in the bank, so if you have no real plans for your new found lump sum, you might be better off leaving it where it is.
Whether people will accumulate pension funds over their lifetimes and then rush to splurge in one go given the new flexibilities, remains a point of much debate. But those who do go down that route need to seriously consider how such a strategy will affect their longer-term retirement planning. It’s a fact that we are all living longer, with the average life expectancy now 85 for men and even older for women. If you spend your pension fund now, you need to make sure that you have a fall back plan for income later on in retirement.
When the changes were first announced, the government pledged to provide free retirement “advice” for all. They immediately back-tracked on this and clarified this would be “guidance” only, which means that you will get general guidance on the options available to you, but not personalised advice. Operating under the banner of Pension Wise, guidance will be offered either over the phone from the Pensions Advisory Service or face to face at the Citizens Advice Bureau. The Government says that staff will be trained to “rigorous” standards, but the fact remains that they will not be able to give you advice. For that you will still need to see a financial adviser.
Public Sector Employee?
There will be restrictions on schemes that promise a pension that is related to salary (defined benefit schemes). People working in the private sector who pay into defined benefit schemes will be able to transfer into a personal pension and then cash that in, but they will have to take independent financial advice first.
However, people working in the public sector, such as teachers, NHS staff, civil servants, firefighters, police etc. will not be able to make use of pension freedom legislation. This is because their schemes are “unfunded” and there is no real pot in existence from which to fund a transfer value. These differ from schemes in the public sector that are funded, including all the local government pension schemes and the Universities Superannuation Scheme, who will be able to transfer out.
Confused? We would always urge you to seek professional advice, be that from a financial adviser or by using the Government-funded guidance service. For a free initial consultation with one of our Consultants, please contact [email protected].
Please note that the information provided in this article is in no way intended as advice and is provided for information purposes only. You should seek formal advice from an advisor or guidance from the TPAS/CAB, before taking any action in respect of your pension fund.