Pension freedoms

Decisions about how to access your pension pot

‘The secret to happiness is freedom’, wrote the ancient Greek historian Thucydides. And with the introduction of the pension freedoms rules, those aged over 55 now have far greater freedom of choice over how they use their pension pot to fund their retirement years.

When pension freedoms commenced during the tax year 2014/15, it dramatically changed the pensions landscape. How people can now access their retirement income is substantially different from previous generations. Pension freedoms have made it much easier for people to access their pension pots and as a result some may think they can do it themselves.

Little knowledge and understanding
Pension freedoms have put a greater onus on people to keep themselves informed of their options when it comes to accessing their pension money. However, little knowledge and understanding of the rules could mean some people risk making decisions that are not best for them.

For people in their 40s and 50s, understanding retirement savings is especially critical. Pension freedoms now give savers full access to their retirement savings from the age of 55. The reforms have given over-55s greater power over how they spend, save or invest their retirement pots.

Leaving retirees with different options
You can now take your entire pension pot as cash in one go if you wish. However, if you do this, you could end up with a large Income Tax bill and run out of money in retirement. It’s essential to obtain professional advice before you make any major decisions about how to access your pension pot.

Deciding what to do with your pension pot is one of the most important decisions you will make for your future, and now you can access your pension in more ways than ever before. This leaves retirees with different options, from withdrawing lump sums in cash as and when needed to staying invested and drawing income, or to use how they wish. It is still possible to opt for the traditional route of buying an annuity offering a guaranteed income.

“Half of Britons aged 55 and over (51%) admit they know little about the pension freedom rules introduced in April 2015, according to new research[1]. A further one in ten (10%) over 55s say they know nothing about the changes, which represented a complete shake-up of the UK’s pensions system five years ago[1].”

Consider your personal financial landscape
From 6 April 2015 new freedoms included removing the need to buy an annuity to provide income until you die, giving access to invest-and-drawdown schemes previously restricted to wealthier savers, and the removal of a 55% ‘death tax’ on pension pots left invested. Since its introduction more than £35 billion has been withdrawn by 1.4 million individuals through the pension freedoms, according to HM Revenue & Customs data.

As well as understanding the various options for accessing benefits, when you are deciding what to do with your pension pot, you also need to consider your personal financial landscape. How long do you expect your investments and pensions to remain invested for? What do you want to achieve in the future, and how do you see your retirement playing out? How much investment risk are you willing to take? What income sources do you currently have or need to create, and how are they taxed?

New people reaching pension freedoms age
The pension freedoms changes apply to people with defined contribution pension schemes, which take contributions from both employer and employee and invest them to provide a pot of money at retirement. They don’t apply to final salary or defined benefit pensions, which provide a guaranteed income after retirement.

The number of new people reaching pension freedoms age will reach a peak in 2020, new analysis has revealed. According to the latest Office for National Statistics (ONS)[2] population estimates, it is estimated that the next six years will see consistently high numbers of people turning 55, should the minimum pension age stay at 55 for the foreseeable future.

What are your pension freedom retirement options to consider?
There are a number of different options when you are deciding how to take your defined contribution pension pot.

Leave your pension pot untouched for now and take the money later
It’s up to you when you take your money. You might have reached the normal retirement date under the scheme or received a pack from your pension provider, but that doesn’t mean you have to take the money now. If you delay taking your pension until a later date, your pot continues to grow tax-free, potentially providing more income once you access it. If you do not take your money, we can check the investments and charges under the contract.

Receive a guaranteed income (annuity)
You can use your whole pension pot, or part of it, to buy an annuity. It typically gives you a regular and guaranteed income. You can normally withdraw up to a quarter (25%) of your pot as a one-off tax-free lump sum, then convert the rest into an annuity, providing a taxable income for life. Some older policies may allow you to take more than 25% as tax-free cash – we can review this with your pension provider. There are different lifetime annuity options and features to choose from that affect how much income you would get.

Receive an adjustable income (flexi-access drawdown)
With this option, you can normally take up to 25% (a quarter) of your pension pot, or the amount you allocate for drawdown, as a tax-free lump sum, then re-invest the rest into funds designed to provide you with a regular taxable income. You set the income you want, though this might be adjusted periodically depending on the performance of your investments. Unlike with a lifetime annuity, your income isn’t guaranteed for life – so you need to manage your investments carefully.

Take cash in lump sums (drawdown)
How much of your money you take and when is up to you. You can use your existing pension pot to take cash as and when you need it and leave the rest untouched, where it can continue to grow tax-free. For each cash withdrawal, normally the first 25% (quarter) is tax-free, and the rest counts as taxable income. There might be charges each time you make a cash withdrawal and/or limits on how many withdrawals you can make each year. There are also tax implications to consider that we can discuss with you.

Cash in your whole pot in one go
You can do this, but there are important things you need to think about. There are clear tax implications if you withdraw all of your money from a pension. Taking your whole pot as cash could mean you end up with a large tax bill – for most people, it will be more tax-efficient to use one of the other options. Cashing in your pension pot will also not give you a secure retirement income.

Mix your options
You don’t have to choose one option. Instead, you can mix them over time or over your total pot when deciding how to access your pension. You can mix and match as you like, and take cash and income at different times to suit your needs. You can also keep saving into a pension if you wish, and get tax relief up to age 75.

Retirement savings intended for later life
Estimates show 941,000 people will be turning 55 in 2020 – more individuals than any other age in the UK. Population estimates over the following six years also show that those approaching the age of 55 will consistently total above 900,000.

The coronavirus (COVID-19) crisis has thrown some of the nation’s retirement plans up in the air, but the full impact will depend on where your pension is invested. For those aged 55 and over, even though it is positive that people have the option to use retirement savings intended for later life earlier to reflect their situation, just because you can access pensions early, it doesn’t mean you should.

Accessing pension funds earlier than planned
The result of the COVID-19 pandemic may see a significant number of individuals accessing pension funds earlier than planned with others thinking about this. While this may alleviate short-term financial pressures, it leaves less of a retirement fund to provide an income throughout what can be decades of retirement. Taking larger amounts out of pensions can also mean paying more income tax and it may be better to consider alternative options.

It’s always important to think ahead to retirement and plan for the future, and even more so as we face up to the coronavirus crisis. Don’t rush into making life-changing financial decisions – to make an informed decision about what is best for you, please contact us to review your situation.

You may wish to read our Guide to Pension Freedoms

Source data:
[1] Standard Life’s research of more than 2,000 UK adults found 35% of Britons aged between 55 and 64 have already accessed their pension pot, prior to State Pension age
[2] https://www.ons.gov.uk/peoplepopulationandcommunity/populationandmigration/populationestimates/datasets/

TAKING WITHDRAWALS MAY ERODE THE CAPITAL VALUE OF THE FUND, ESPECIALLY IF INVESTMENT RETURNS ARE POOR AND A HIGH LEVEL OF INCOME IS BEING TAKEN. THIS COULD RESULT IN A LOWER INCOME WHEN THE ANNUITY IS EVENTUALLY PURCHASED.