Proposed pension changes:- Tax-free or not tax-free – that is the question…

You can tell it’s nearing election time – political parties start to make all kinds of impressive-sounding promises that might not be quite what they seem.

One promise is that from next year people over the age of 55 can use their pension pot like a bank account. They will, whenever they like, be able to withdraw lump sums from their pension funds. Of these withdrawals, 25% will be tax-free but the rest will be taxed at the normal tax rate. So, if you’re over 55 and you want to withdraw money from your pension, you won’t have to pay tax if the amount you withdraw, plus your income, equals no more than £10,000. However, if your income and withdrawal amounts combined are over the £10,000 mark, you should expect to pay tax on any money you earn or withdraw over that amount.

The new pension changes due to come in from 6 April 2015 seem to offer a lot of welcome freedoms for pensioners. Pensioners will be able to:

  • buy an annuity if they want to;
  • take money out whenever they need to; or
  • take all their money out.

However, pensioners will need to think carefully about whether they will still have enough income if they use up their pension savings.
The Government is passing this responsibility down to pensioners.

In any case, some pension companies may simply decide not to change how they run their pensions – they won’t have to incorporate the new proposals. And many pension providers are already worried that they simply won’t be able to afford to bring in the new changes, even if they wanted to.

If pension providers adopt the changes, the proposed pension reforms will mean people over 55 with pension savings won’t have to buy an annuity when they retire. However, they can, if they prefer and want the security of knowing how much pension income they will have in future.

While many of us will have the ability to look after our pension savings, many others have no experience of investing wisely or have a clear understanding of pensions or financial matters in general. They will need expert financial help and advice in dealing with what is a potentially extremely complex issue.

The UK tax system adds to the potential confusion. It would be easy to make the mistake of making a large withdrawal from a pension scheme without realising that the withdrawal may create a tax bill. Non-taxpayers may find they have to pay tax and basic-rate taxpayers could end up paying higher-rate taxes. So, getting advice from experts may be expensive but the eventual savings could be well worth it.

Here are brief explanations of some key pension terms. There are many more examples on our website.

Annuity A set amount of money paid each year.
Beneficiary Someone who may benefit from a pension scheme.
Defined contribution pension A scheme on which the amount of pension to be paid will depend on:
 
  • what has been paid into the scheme;
  • how the pension pot has grown; and
  • how much pension can be bought with the pension pot.
Drawdown Drawing an income or lump sum from your pension fund.
Lump sum A large amount of money paid in one go (not in installments).
Tax free lump sum At the moment, when you retire, you can take a tax-free lump sum of 25% of your pension fund. You would pay tax on the other 75%.
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