Pensions. Probably not the most exciting topic in the world. But from April 2015 they’re set to become a whole lot more interesting.
How? Well, they’ll be much more flexible and accessible than ever before.
When the change was announced, it made headlines and fired up imaginations around the country for one very big reason. That you will soon be able to draw the whole of your pension plan out – in cash.
The press think we are all going to blow our hard-earned savings on Ferraris and cruises and rely on the state when it’s all gone. Some people have been criticised for wanting to use the money to repay their debts. So what do you need to know? And what should you do?
What is going to change?
A pension plan is really just a long-term savings pot, a bit like an ISA’s older brother. Just like an ISA there are limits to what can be paid in every year and it grows, tax free.
They are especially attractive when you pay money in, because your contributions attract income tax relief. For example, it costs a basic rate tax payer £800 to pay a contribution of £1,000. It costs a higher rate tax payer only £600.
When it comes to taking money out, you can usually draw 25% as a tax-free lump sum. At the moment the rest must be used to provide a pension for life.
This is where the change comes in. From April 2015 that remaining pot can just be taken out as a lump sum. But in both cases, no matter whether it’s paid as a lump sum or an income, that money is taxed as if it was income.
That means it could be subject to 20%, 40% or even 50% tax depending on your other income (unless you are only taking up to your personal allowance, currently £10,000 for most people, which is not taxed at all).
Things to consider…
- What do you want to achieve? If you’re thinking about accessing the money in your pension pot, ask yourself: What do you want the money for? When do you need it? What is your objective?
- The big picture. The best thing to do when making any decision that has an impact on your finances is to look at the whole picture. Your pensions are part of your overall wealth. Make sure you know what savings and investments you have, how much they are worth and what they are for. What do you have now? How will that change in the future?
- Look at your options. There may be other ways to raise the money you need, such a ISAs, premium bonds, or perhaps a rental property. You may be able to take money out of a business or even access money from a trust. They will all have pros and cons to consider, the greatest of which will probably be tax.
- Calculate the costs and taxes. Remember that if you take money out of a pension pot, you will pay up to 50% income tax on three quarters of the amount you take out. Once outside the pension plan (which grows tax free), anything that the money then makes could also be taxable (just like the interest on savings accounts is taxed, for example).
There are probably only a few instances where I’d advise you to use your pension pot for one-off spending. These are if you:
- Don’t have any other savings or investments you can use.
- Are not a taxpayer and only want to take out enough to use your personal allowance.
- Want to spend (or gift) the money straightaway.
Making it last
Your savings and investments need to last you for the whole of your life. Unfortunately, our lives don’t run in straight lines. We need more money at some points and less at others.
The new pensions rules mean that you will have the flexibility to control how much money you have to spend at any time: more in the early years of retirement, less in later years and probably a big peak in the final couple of years to fund specialist nursing care.
You may want to leave money for your family. Whatever the circumstances, you need to make your money last.
The best way to do that is to have a forecast of your wealth for the rest of your life. You can do this roughly on a spreadsheet or using some free online tools. Most professional advisers can also do this for you.
It’s your money!
Don’t forget, your pension is your money. For some people they seem like distant pots of cash over which you have no control but that simply isn’t true. They will be funding your future.
Some people use their pensions to buy a new business premises. They can even be used to help get a change of lifestyle off the ground, by buying agricultural land or a campsite. They are more flexible and interesting than most people think.
What I often see is pension pots that people have had for years that are never reviewed, extremely expensive and invested inappropriately. They could be losing thousands of pounds in charges and poor performance. It doesn’t need to be that way.
Get on top of your pension plans yourself, or speak with a professional adviser. They will usually save you many times what you pay them in fees, and you will feel much more in control of your financial situation.
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