With seemingly complex pension reforms in place last week, Matthew Bird explains the 11 things you need to know to make sense of the revised regulations.
Since Monday, ‘Flexible Drawdown’ or leaving your pension pot invested while taking lump sums/income from it, is now available to all pension savers approaching retirement age, who now have the freedom to access their pension pots as they wish.
Do seek independent advice – the suitability of drawdown, which is a more flexible option for many, will depend very much on the circumstances of each individual. Drawdown enables you to use your pension as a bank account and drawn sums out, but there is a huge array of options available and while annuities may be the best option for some, a mixture of an annuity and drawdown may suit others, which is why proper advice is essential.
In theory, you could pull out the entire lot in one hit, as the new regulations mean you’re no longer shoe-horned into purchasing an annuity, (which pays out a certain amount per year, for the rest of your life.) But this is undoubtedly a bad move for most, as the withdrawal will be counted as income and taxed at marginal rate (which could be up to 45%)
Appetite for risk
As a rule of thumb, drawdown will suit those who have a higher appetite for risk, as it generally involves staying invested for longer and shouldering some investment volatility.
Appeal to those with other income provisions
It will probably also appeal more to those with other retirement income provisions, and therefore a fall back and greater capacity to cope with potential loss.
For a 60-year old married person looking to buy an annuity (an income for life) with a 50% spouse benefit and index linked payment, the annuity rate they would receive is about 2.5-2.7% (assuming the applicant is fit and healthy.) If the individual was willing to continue to stay invested and access the pension via drawdown, it is feasible that he/she could take 4% a year as income, have better death benefits, and also possibly still benefit from future investment growth.
Tax on income
If you choose to either buy an annuity or take income drawdown, you will only pay tax on the income, although wherever total income is below £10,600 in 2015-16, you will not pay anything.
Tax free portion
The tax free portion of your pension (25%) can now be taken as a part of regular income. So those who have no real need of a huge lump sum at retirement (which would sometimes subsequently be stuck in a tax-inefficient, low interest savings account) can now take it bit by bit and have the benefit of maintaining the majority of their retirement savings in a tax-free environment.
Bricks and mortar risks
Those thinking of raiding their pension nest egg to fund a buy-to-let property must carefully consider the benefits. Residential property is not very tax efficient in comparison to pension savings, and being a landlord can be fraught with dangers, especially if using mortgage leverage into retirement to help finance property purchase.
Lifetime allowance limit
The reduction in lifetime allowance limit on pensions to £1m is very restrictive, though government reasons for doing this are that it will save the economy £600m annually. Time will tell, but the level does penalise regular employees trying to plan their pensions and prepare for the future. While £1m sounds a lot, when annuity rates are 2.5%, it amounts to roughly £25,000 a year from £1m of savings.
With the government’s launch of a consultation on a secondary annuities market coming into force (which means insurers will be able to bid to buy annuities from retirees, who weren’t actually their customers originally), retirees would be able to reconvert their annuity income into upfront cash, which provides yet another option.
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