Pension Freedom
So you’ve seen all of the press, read all about it and you’re ready to cash in your pension for a lump sum. But is that really the right thing for you to do?
In a rather unexpected announcement, George Osborne revealed in his 2014 Budget that from April 2015 pensioners would have completely flexibility to access their pension savings. No longer would they have to buy an annuity for life or utilise the rather strict income drawdown rules, quite simply you will be able to take as much, or as little, as you want whenever you want.
To relieve the burden on the state pension system, in recent years we have seen the introduction of workplace pensions whereby employers have had to automatically enrol employees into a pension scheme. With the added introduction of these new freedoms from April, the government are rather relying on pensioners being responsible for their own future and expecting them to manage their income appropriately. But, as the pensions minister Steve Webb alluded to, there’s nothing to stop somebody from blowing their whole pension fund to buy a Lamborghini and then expecting to rely on the fallback security of the state pension – exactly what the government have been trying to avoid.
So, is taking the whole of your pot as a lump sum a good idea? Well, that will depend on individual circumstances and taking proper advice is paramount – but there are a number of very important factors that you should be aware of.
Future income
You work for 30 to 40 years (or even more) of your life, all the while saving into a pension that you intended would provide your income in retirement. Taking some or all of your pot as a lump sum might sound an attractive thing to do, but by splurging on that new car or round the world cruise you’re writing off the benefit of any future income that a pension might’ve provided and that you saved for all those years.
If you have no other pension provision you’ll be heavily reliant on the state pension which is designed to provide not much more than a basic sustenance (£151.20 per week for 2015/16).
Means tested state benefits
Taking a large amount of cash from your pension could affect entitlement to benefits that are tested against capital/savings, like pension credit, housing benefit and council tax support.
The government intends to issue guidance on how pension freedoms will interact with Department for Work and Pensions rules, however, as things stand currently, withdrawing cash from a pension and putting it into cash or other investments might put you above the means tested limit and make you ineligible for benefits, meaning you may end up having to spend that cash on rental payments or council tax that you could otherwise have had help with.
Tax
Whilst in most cases the first 25% of any lump sum will be paid tax free, the rest of the lump sum will be added to the rest of your taxable income and will be subject to income tax at your highest marginal rate.
Pension providers will be obliged to deduct basic rate tax at source (20%) and any amount that lifts you into the higher rate tax bracket (£42,385 for 2015/16) will be subject to tax at 40%. That tax will most likely be collected by an adjustment to an individual’s tax code, so for someone still in employment taking a lump sum from a pension could actually have a negative effect on take home pay.
Reduced annual allowance
HMRC rules currently allow individuals to contribute up to a maximum of £40,000 per year to a pension and still get tax relief on contributions. To stop people from abusing these rules by withdrawing large sums from their pensions and immediately paying it back in to benefit from tax relief, the government have introduced a new reduced annual allowance of £10,000 for anybody who flexibly accesses their pension after April.
Whilst this reduced limit might not pose much of an issue for many, anyone still contributing large sums to their pension might be adversely impacted.
In summary, whilst the headlines make the notion of pension freedom sound very appealing, never has it been more important to take advice about your pension before making any decision. The government have introduced the new guidance service under the guise of Pension Wise, however this is essentially an information service. Thankfully, Pension Wise will be signposting people toward independent financial advisors such as ourselves. If you’d like to skip the guidance step and come straight to us, please contact us for a no-obligation meeting with one of our consultants.