This is probably the most complex and important financial stage of your life. In this section we bring together all of your assets to develop a retirement plan.
On 6 April 2015 new pension rules came into force giving you much greater flexibility over how you use your money purchase pension savings and the options you have in retirement.
These changes include the freedom to control how you access your pension fund, more choice over how to receive the tax-free cash from your fund, changes to death benefits and changes to the contributions you can make.
Whether you have a personal pension, a group personal pension or a stakeholder pension these new rules are far-reaching, and they could have significant tax implications. It is therefore important to take advice on the various options open to you.
The first of the new options is "flexi-access drawdown" which in essence places no limit on the amount of income you can take from your money purchase pension fund once you reach the minimum pension age, currently 55. This means that it would be possible to take the whole of your pension fund in one go, however it may not be tax efficient to do so.
If you will be dependent on your pension fund to support you through your lifetime you may need to consider taking a lower level of income to sustain you.
You will be able to take up to 25% of your fund in phases as a tax free lump sum, if you have not previously used that fund for drawdown purposes, with the remainder of the fund staying in your pension, growing tax free to provide you with an income.
It is important to remember that the amount of flexi-access fund withdrawn to provide you with an income will be taxed at your marginal rate of income tax, therefore, if you take too much income this may move you into the next tax bracket, and result in you paying a higher rate of tax.
Pension Lump Sum
A new option has been introduced by the Government which is called the Uncrystallised Funds Pension Lump Sum (UFPLS).
This option is for funds not already in drawdown and allows you to take a one-off payment from your pension or a series of lump sums leaving the remainder of the fund in your pension invested, the first 25% of each UFPLS is tax free, with the balance being subject to tax.
UFPLS is not available from any part of your pension that is already in drawdown.
How can I access the new pension's options?
For anyone who was in drawdown before 6 April 2015 (capped or flexible) the new options differ depending on which one you have had.
Currently if you are in capped drawdown you will have a maximum level of income that you can take each year and this is reviewed every three years up until you are 75 and annually thereafter.
From 6 April 2015 you were able to continue to take capped drawdown or you have the option to switch to the new flexi-access drawdown whereby the amount of income you can take will be unlimited and there will be no further maximum income level reviews.
It is important to remember that if you take the decision to move from capped drawdown to flexi-access drawdown and take any income from the flexi-access drawdown fund the amount you can contribute to money purchase pensions each year without suffering a tax charge will reduce.
Anyone who had a flexible drawdown plan before 6 April 2015 automatically had their plan renamed flexi-access drawdown on 6 April 2015. This had no effect on how you take benefits but it does now enable you to make tax-efficient contributions of up to £4,000 each year to money purchase pensions.
New Death Benefit Rules
You can nominate whoever you choose to receive your death benefits, this can be your spouse, children, grandchildren or even someone unrelated to you, you can also leave some, or all, of your pension fund to charity.
The beneficiaries of your pension fund can elect to take the fund as a lump sum or leave the fund invested and take an income under the new flexi-access drawdown rules. If they do choose the flexi-access option then they can take income as and when required or leave the funds invested, thereby benefitting from the tax advantaged pension.
What about tax on the death benefits?
The tax treatment of your death benefits will depend on two things.
- ▲ Your age when you die.
- ▲ Whether or not the funds are designated to your beneficiary within two years.
If you die before your 75th birthday and your pension funds have been designated to your beneficiaries within two years they will be paid tax-free. If the beneficiaries choose drawdown, the funds must be placed in their drawdown pot within 2 years but they do not need to take the money out of the drawdown plan within the two year period.
If you live beyond your 75th birthday or if you die earlier but your pension funds are not designated within the two year period, then the death benefits will be taxed; the taxation that would normally be applied would be at the beneficiary's marginal rate of income tax.
If your beneficiary has not withdrawn the whole of the pension fund before their subsequent death then the pension funds can be passed on again. Your beneficiary will be able to nominate anyone they want the funds to go to following their death.
It is possible to have unlimited successors so in essence your pension fund could be passed on for generations if it is not all withdrawn. Each time the fund is passed on, the tax position is based on the age at death of the most recent beneficiary (tax free if they die before 75 and taxed at the beneficiary's' rates if they die after 75).
You will of course still have the option of purchasing an annuity which for some people may still be the right choice, to give a guarantee of an income for life, paying a level income or increasing over time.
Converting all or part of your pension into an annuity will provide a guaranteed regular income, which will be paid for the rest of your life by the annuity provider of your choice.
Regardless of the options available for taking withdrawals from your pension savings, an annuity could still be the most suitable choice for many people. In addition, as a result of the pension rule changes, different types of annuities are becoming available.
may want to use part of your savings to fund your immediate income needs and then review what choices are available to you later.
You will have to pay tax on your annuity income in the same way as paying tax on a salary (above the personal allowance). Typically you would take your tax-free lump sum before buying an annuity.
The basic types of lifetime annuity available are:
- ▲ Single-life or joint-life annuities - This pays you an income just for your lifetime and ceases on your death.
- ▲ Level or escalating annuities - You can choose whether you want your single or joint-life annuity income to stay at the same level or to increase each year (known as "escalating").
- ▲ Investment-linked annuities - They invest the value of your pension pot in investments such as stocks and shares. It offers potentially higher income, but also involves some risk that your income could go down as well as up in line with investment performance.
- ▲ Annuity protection lump sum death benefit - This is a way of ensuring that if you die, your annuity may provide a lump sum.
- ▲ A guarantee period - if you die shortly after buying the annuity, it will not have paid out much and the beneficiaries of your estate will get nothing back. To guard against this, you can choose an annuity with a guarantee period.
- ▲ Enhanced annuity - you may quality for a higher annuity income if you have a lower than expected life expectancy e.g. due to smoking or being overweight.
- ▲ Flexible annuities have also became available which will allow the income level to decrease as well as increase providing this is stated in the annuity when the contract is started.
Income Drawdown plans are complex. It's a good idea to get professional advice because what you decide will affect your pension income for the rest of your life.
Income Drawdown is a more flexible alternative to the traditional annuity route, offering greater choice and control for many people.
You can put off buying an annuity, and instead withdraw a regular income or take ad-hoc withdrawals from the pension fund while the remainder of the fund stays invested. While the fund remains invested you could benefit from tax free growth in the market. If you choose this route it is beneficial to take ongoing financial advice.
Anyone from the age of 55 (expected to rise to 57 from 2028 and then remain 10 years below state pension age) can set up a Drawdown contract. It could be suitable if you:
- ▲ want to vary your income over time to reflect changes in your circumstances
- ▲ want your pension fund to continue benefitting from potential investment growth and you're prepared to accept the risk that the value of the fund may fall
- ▲ have other sources of income
- ▲ want to maximise the benefits your family receives upon your death, and also give more choice about how they receive these benefits
- ▲ are in ill health, and would like to pass on remaining assets to your estate
- ▲ want to control the time at which you buy an annuity
- ▲ want to maintain an active interest in managing your pension fund
- ▲ have a pension fund in excess of £100,000.
Typically, Income Drawdown suits people who are not averse to investment risk and who have larger pension funds.
However, there are no guarantees that income will be greater than if the fund was used to purchase an annuity at retirement. There is also no guarantee that the initial income level selected will be maintained. The costs of Income Drawdown are normally higher than for an annuity.
Pension freedoms have now given you control. You can now manage how and when you access your pension to supplement your income so that you can produce a retirement plan.
You now have the ability to slow down after age 55 and dip into your pensions to top up your income. If you benefit from an inheritance or go back to work you can turn off the drawdown income until it is required again.
If you do not need the income from your pension you could use it to mitigate inheritance tax. See the tax planning section.
If you are younger than the state retirement age you could top up your income to use your personal allowance using the following options:
- ▲ Small pots
If you have not started taking any pension income and you have some small plans with a value below £10,000 (maximum of £30,000) you are able to take them in one go. You can take 25% tax free and on the remaining fund you will pay income tax at your marginal rate.
- ▲ Lump Sums
You can take part or all of your pension savings as a lump sum which can be useful to cope with any immediate needs.
- ▲ Phased Drawdown
You are now able set up a monthly withdrawal; 25% tax free, 75% taxable.
- ▲ ISAs
You can blend in the income generated by ISAs or sell capital units to provide tax free income.
- ▲ Venture Capital Trusts
If you have any eligible VCTs they are able to pay out dividends free of income tax.
- ▲ Investment Bonds
It is possible to withdraw from either onshore or offshore bonds without paying any immediate income tax.
Deferring your State Pension
If you do not require your state pension when you receive your state retirement age, you can defer it and receive extra benefits.
Equity Release Schemes
Assuming you do not have an outstanding mortgage, you are also able to borrow against the collateral of your home. However, this is not suitable for the majority of people see the mortgage section.
This is dealt with more thoroughly in the tax planning section. The key point is that the pension value is outside the estate.
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