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Pension Freedom: Making the right decision

By The Orchard Practice

During last year’s Budget announcement, the Chancellor introduced the prospect of pension changes. These changes were confirmed in the Taxation of Pensions Act 2014 and have now taken effect.

Pension FreedomThe freedom granted by these changes is good news for all pension savers but could lead to many people making bad decisions and paying unnecessary tax. That’s why it’s important to understand what the changes mean to you and why professional financial advice can help you make the right decisions with your pension.

1. Greater freedom over how you take tax free cash

Most people can now take up to 25% tax-free cash from their pension, either by:

  • Taking your Pension Commencement Lump Sum in full, with subsequent withdrawals taxed as income; or
  • Making a series of withdrawals over time, receiving 25% of each withdrawal tax free.

2. Flexible access from age 55

People over the age of 55 will have greater power over how they invest their retirement savings and more choice in terms of the options available. You can now:

  • Take the whole fund as cash in one go
  • Take smaller lump sums as and when needed
  • Take a regular income – via income drawdown, or an annuity

Choosing to take your pension in stages, rather than in one go, could help you manage your tax liability.

4. Restrictions on how much you can contribute to pensions

Pension contributions are subject to a £40,000 annual allowance and specific contribution rules. This remains true under the new rules.

However, if after 6 April 2015 you make any withdrawals from your pension in addition to any tax-free cash, contributions to defined contribution plans will be restricted to £10,000.

5. 55% pension “death tax” to be abolished

Up until April 2015, it was normally only possible to pass a pension on as a tax-free lump sum if you died before age 75 and you had not taken any tax-free cash or income. Otherwise, any lump sum paid from the fund was subject to a 55% tax charge.

From April 2015 this tax charge was abolished and the tax treatment of any pension you pass on will depend on your age when you die:

  • If you die before age 75, your beneficiaries can take the whole pension fund as a lump sum or draw an income from it tax free, when using income drawdown.
  • If you die after age 75, your beneficiaries can:
  1. Take the whole fund as cash in one go: the pension fund will be subjectto 45% tax. (From April 2016, lump sums will be taxed at the beneficiary’s marginal rate).
  2. Take a regular income through income drawdown or an annuity (option only available to dependants): the income will be subject to income tax at your beneficiary’s marginal rate.
  3. Take periodical lump sums through income drawdown: the lump sum payments will be treated as income, and subject to income tax at your beneficiary’s marginal rate.

Income drawdown carries significant investment risk as your future income remains totally dependent on your pension fund performance. HM Revenue & Customs practice and the law relating to taxation are complex and subject to individual circumstances & charges which cannot be foreseen.

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