The rule changes come as pensions go through a major overhaul. Changes in the law with the introduction of what’s known as “Automatic Enrolment” also mean that you could be getting extra money from your employer paid into your Workplace Pension each month.
Drawing a lump sum
Currently, you can draw up to a quarter of your pension pot as a single lump sum payment, tax free.
Many people have viewed this as an attractive option when weighed against using the entire pension pot to purchase an annuity – an investment vehicle designed to provide guaranteed income during retirement. As with income in general, the monthly payments you receive from an annuity are subject to income tax.
Sweeping change
From April 2015, however, sweeping changes under pension reform designed to give people more flexibility and control over their pensions means that the over 55s will be able to take a number of lump sums from their pension pot, with 25% of each sum being free of tax.
So instead of just being able to take one lump sum at retirement you will be able to take various lump sums on different dates. And what makes the changes particularly revolutionary is that you will be able to gain access to your pension in this way without having even retired.
Provided you are aged 55 the options will be:
- Take your whole pension fund as one cash lump sum with 25% tax free and the rest taxed as income
- Take smaller lump sums, as and when you like with 25% of each withdrawal tax free and the rest taxed as income
- Take up to 25% tax free and a regular taxable income from the rest
Your choices
So what should you do? The best option for you is going to depend on your personal circumstances. For many people, taking one lump sum tax free payment may not be the most optimal choice that it was once. Having the freedom to do this on different occasions gives you a lot more flexibility.
You also need to remember that the money you have saved in your pension is intended to finance your retirement for the rest of your life. Spending more in the early days of your retirement could mean having a lot less to live on in later years’.
At the same time, using a tax free lump sum withdrawal from your pension fund to pay down debt or reinvest in a tax efficient savings vehicle such as an ISA could be a good choice for some.
With so many more choices than before on how you manage your pension pot, it makes sense to seek independent financial advice. As you could easily spend 20 or more years in retirement, it’s important to ensure you secure enough income from your pension pot to last out your entire retirement.
For more information about the positive impact of pension reform visit our Workplace Pensions hub We're All In.
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