The new pension freedoms
New pensions rules that provide more flexibility and choice on how you can take your pension came into force on 6 April 2015.
We’ve set out the main changes and what they mean for you now, when you come to retire, and afterwards. The effects of these changes and the pension tax rules in general as well as the value to you of any favourable tax treatment will depend on your individual circumstances. You should always bear in mind that, just as these rules are changing now, they can change again in future; you need to take account of that in any planning that you do.
You can also:
There are no real changes here.
There’s a limit to how much you, your employer and anyone else can contribute to your pension each tax year and receive tax relief. It’s called the Annual Allowance. For most people, this year it’s either 100% of your earnings or £40,000, whichever is lower. Although, those who earn over £110,000 and have “adjusted earnings” in excess of £150,000 this allowances is tapered. Find out more about your allowances.
You still have an allowance if you’re not currently paying tax or receiving earnings, of up to £3,600 per year (and this applies across the board, so that for instance you can pay £2,880 into a pension for a minor child, and the government will top it up to the £3,600). If you go over the limit, you’ll be taxed. It is possible to “carry forward” unused pension allowances from the last 3 years, and in this way (so long as it is within the above limit for the current year) you can pay in more without being taxed.
Remember though if your Annual Allowance has been replaced by a Money Purchase Annual Allowance you can only contribute £4,000 and can no longer use Carry Forward. Find out more about your allowances.
There’s also the Lifetime Allowance (LTA), which is the maximum permitted value of all your pensions without paying extra tax. For most people, from 6th April 2016 the LTA is £1.0m. This will then be index linked (CPI) from April 2018.
Until recently you could take some of your pension pot as cash, but not all of it, unless the total of all your pensions was less than £30,000. Before the changes, you could withdraw up to 25% tax-free but you’d need to use the rest to buy an annuity or to set up “income drawdown”, where your money remains invested and you draw an income from it.
Now you can take as much of your pension pot in cash as you want to. The first 25% of what you take will still be tax-free, but the remainder of what you take will be taxed as income. You may hear this called an Uncrystallised Funds Pension Lump Sum (UFPLS) – it just means you have the flexibility to take out as much money as you want when you want it.
The tax consequences for the taxable 75% could, however, be expensive for you, as, depending on how much you take and how much other taxable income you have in the tax year, it could push you into the higher-rate tax bracket, and/or cause you to forfeit your income tax personal allowance (where taxable income for the year exceeds £100,000). It could also push some of it into the additional rate bracket (currently 45%, where taxable income for the year exceeds £150,000). So judicious planning will be needed.
If, alternatively, you want to take some money out but leave the rest in to give you an income, you can use Flexi-Access Drawdown (FAD). Under FAD, you can take out up to 25% entirely tax-free and leave the rest in the pot to give you an income, which will be taxable when you take it, whenever you want for as much as you like. You no longer need to have a minimum guaranteed income to use drawdown.
Finally, the age at which you can start using your pension is still 55 but its set to rise to 57 by 2028.
Once you’ve retired, if you’re already using flexible drawdown to draw an income, you’ll have been automatically switched over to FAD on 6 April 2015. If you’re using capped drawdown – where the amount you can take each year is limited – you can choose to move it to FAD.
If you decide to use FAD (draw an amount above 25% from your pension) or take an Uncrystallised Funds Pension Lump Sum (which means draw out all of your pensions savings, paying tax on all amounts above 25%) you won’t have the Annual Allowance any more to make future contributions to pensions. Instead, you’ll have a Money Purchase Annual Allowance (MPAA) of only £4,000 per year. Unlike the Annual Allowance there’s no option to carry forward.
Previously there was a 55% tax charge on pension funds when you died, where benefits were paid as a lump sum.
Now, pension funds inherited from a pension holder who dies before age 75 will not be taxed. A pension passed on after age 75 will either be taxed at the beneficiary’s income tax rate if taken as an income or at 45% if taken as a lump sum (this is expected to reduce to the beneficiary’s marginal rate from April 2016).
Pension funds are passed from a pension holder to beneficiaries, nominated by the plan holder. They each have a choice in how they use their assigned funds which is affected by the age at which the plan holder dies.
Each beneficiary can draw the funds as a lumps sum, use it to draw an income or defer it until a later stage.
If the original planholder dies before age 75, benefits when drawn will not be taxed.
If death occurs after age 75, it is subject to the marginal rate of income tax that applies to the beneficiary when benefits are drawn.
If you’re thinking about withdrawing from your pension, it’s important to think about the immediate tax consequences for you, as well as how you’ll fund your retirement in the long term.
Pensions Wise is a free and impartial government service that helps you understand your new pension options and you can find out more at www.pensionwise.gov.uk
Guidance on the options available to you will only be a start, as it is not the same as advice based on your particular circumstances, which you might need as well.