How to wrap your head around next month’s pension changes

From April 2015 we will have the freedom to do as much or as little as we desire with our pensions, due to new plans which aim to revamp how we use our pensions outlined by George Osborne in March 2014. This article will examine what these changes will mean in practice for you and me.

What is changing?

We’ve always been allowed to take a quarter of our pension in a tax-free lump sum, but from only next month savers over the age of 55 will be able to do whatever they please with their state pension. It’s not certain, however that the pension age will remain at 55 for long. It’s expected that the government will link pension freedom to around 10 years before the retirement age, which will soon rise from 67 to 68. None of this is certain, however. Fintechs (Financial Technology Companies) like Nutmeg are also changing the game with their personal pension plan with the help of an all digital platform, opening up the doors to younger audiences, encouraging them to think about their futures and offering a freedom of choice that previously didn’t exist in the pension world.

How will this benefit anyone?

Those who will gain most from this are individuals who have built up large pension pots, who by using this new system can be taxed a lot less than they otherwise would. For example, if you have a £200,000 pot, you could cash it in from April 2015 and have £50,000 tax-free, but the remaining £150,000 would be liable for tax. This means that, depending on the individual’s personal allowance and other earnings, a lot of it will be swallowed up by 40% tax – as much as £53,600.

But if the person decides to take the pension instead as £50,000 each year for four years, then each year he or she will receive £12,500 tax-free and be liable for income tax only on the remaining £37,500, which could be as low as £5,500. So instead of paying more than £50,000 in tax, the person pays around £22,000.

What if I don’t have a large pension pot?

Nothing too drastic, but it’s still work withdrawing your money over a few years so it’ll be taxed less. Say you have £40,000 in pension savings, and immediately take a large amount of money after you retire, then you’ll get £10,000 tax-free and be required to pay tax on remainder. However, if you withdraw £10,000 a year for four years the pension will be tax free given the personal allowance of £10,000.

In a way pension pots will be able to function as a kind of bank account, with the money available to access whenever you desire from the age of 55. There are still kinks in the system to be worked out, and until the plans come into place nobody will truly know how the new system revamp will work out. There could also be disagreements with pension providers, perhaps leading to extra costs, fees or charges.

Do remember to be careful with your pensions, as their importance for your wellbeing as an older citizen is incalculable. In my opinion, unless you’ve got a very healthy amount of money saved up it’s best to treat your pension like usual and withdraw smaller amounts across a long period of time. 

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