How the new pension ‘freedom’ changes affect you

Krys Mayoh

Client Support - Wealth Management

This April saw one of the biggest changes to the pension system in decades. People have been given complete flexibility in how they can access and spend their pension pots. We asked our Wealth Adviser, Krystine Mayoh, to help explain what the new changes mean for you.

So, what exactly has changed?

Under the new regulations starting from 5th April 2015, people on defined contribution pension schemes and who are older than 55 will be able to withdraw their pension pot as one lump sum. Previously people were only able to withdraw 25% of the pension pot, and with the other 75% they had to choose between annuities, income drawdown, and pension schemes. Now people can choose to spend their pension pot in whatever way they want.  

Why have the new changes been brought in?

One of the main reasons is that annuity schemes, the most common pension option, have become increasingly unattractive as a way of funding retirement due to their poor rates. For example a pension pot of £100,000 will only be able to buy an annual income of about £5,500 – not enough for someone to live on comfortably.

And for many people buying annuity was the only option. The other main alternative, Income drawdown schemes, gave a good deal but were only available to a small group of people. This is because they require additional income from another source, such as a defined benefit pension scheme.

What if I’m not in a defined contribution pension scheme?

The new changes do not affect people on defined benefit pension schemes or state pension schemes.

What’s the difference between defined contribution and defined benefit pension schemes?

Defined contribution is where you pay into a pension scheme which is then invested. The amount you receive on retirement is decided by how much the pot has grown and the amount you have paid in. They can either be set up by an employer or as personal pensions.

A defined benefit scheme is an occupational scheme.  The pension you will receive is based on factors such as salary or length of employment, rather than how much it’s grown from investment. These schemes are always set up by an employer.

How will I be taxed if I try to withdraw my pension pot?

You will be able to withdraw 25% of you pension pot tax free and then everything else is taxed as income. This means if you draw down a substantial amount you are likely to pay more income tax than if you draw it as originally designed over many years. 

For example if an individual is earning £30,000 per year and will draw £10,000 per year as a pension they will pay 20% tax i.e. £2,000 per year. If however they withdrew £150,000 in the year the tax due would be £66,000 rather than £30,000 on the pension. This could put you into a higher tax bracket and mean you pay more tax. You should always seek expert advice on tax planning before deciding what to do.

Is this good news for people?

Well, yes and no.

For some it’s great as it gives people complete freedom in how they decide to use their life savings. As explained peoples’ options beforehand were very limited and often didn’t offer good value for money. Now people can choose the right deal for them.

However with the increased freedom comes greater responsibility. Your pension pot has to last you until you die and buying annuity used to guarantee this. Now with the new changes there is the danger that people may choose to spend their pensions in ways that don’t guarantee this, such as investing in risky schemes or spending too much and may well not be left with enough to last their retirement. 

What should I do?

Firstly, don’t rush. You do not have to withdraw money from your pension pot as soon as you turn 55. Indeed you may choose to continue working and paying into your scheme for another decade or so. Consider you options carefully and take advantage the increased flexibility to find the best option for you.

Secondly, you should seek advice from an Independent Financial Adviser. As I have mentioned the new regulations give you a lot more responsibility over your financial wellbeing. Failure to use your pension pot wisely could have serious consequences for you and your family. An IFA can help you find an option that will provide the financial security and comfort you and your family require.

Where can I find further information?

Give us call on 0161 476 8276 or email us at - our financial advisers will be happy sit down with you and discuss what options are available to you.

Source for article: Philip Eagle – Hallidays Tax Director and Krys Mayoh – Hallidays Wealth Advisor
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