Monday, 30 November -0001

Pensions freedoms: top tips from financial planner Michelle Gibbs

Monday is ‘pensions freedom day’

Written by Michelle Gibbs
Pensions-Apr03-02-176For many people, the most immediate notable thing about next Monday, April 6th, is that it's Easter Monday; a day for seeing family and friends, maybe hitting the shops or just enjoying time off work. And not forgetting an excuse for tucking into large amounts of chocolate - for a second day-running.

But Monday is significant for another reason, one that may have passed you by but that is very likely to have a bearing on your life choices – especially if you are approaching 55 or older and have pension savings. Why? Because, Monday is 'pensions freedom day'.

If 'pensions what day?' is your first reaction, then it may be worth spending a few moments reading the short guide below on what many are calling the biggest shake-up pensions have ever seen.

1) What is pensions freedom day?
For the first time nearly everyone aged 55 or over will be able to take all of their pension pot in one go as cash. Prior to April 6th 2015, most people had to either buy an insurance policy that provided an income for life, known as an annuity, or enter 'pension drawdown', where their pension pot remains invested whilst an income is taken from it. These continue to be the options that the vast majority of people are likely to choose, but taking some or all of your pension savings as cash is now also permissible – if not necessarily advisable in many cases.

2) So I can just take the my pension as cash and spend it as I wish?
Yes, but it may not be wise to do so. Whilst this is a potentially great new freedom, there are pitfalls. The tax costs of taking all the money could turn out to be prohibitive because whilst it is possible to take up to a quarter of pensions savings tax-free, the remainder will be subject to income tax, ranging from 20% to as much as 45%.

3) So, it's not sensible to do this?
At the very least, it would (probably) make sense to spread the withdrawals over several tax years to minimize your tax bill. But what may be a more fundamental problem is that taking all the cash immediately or over a handful of years will probably mean you won't have enough left to live on in retirement.

One reason some people may want to cash in their entire pension now could be the desire to make another type of investment, such as a buy-to-let property. Leaving aside whether this is a sensible investment in itself, the tax costs of switching out of your pension pot and into some other investment are potentially huge, giving you much less to invest than you would have if you left it in the pension. Also, there are very wide investment opportunities within pensions. A pension is just a tax-efficient pot for holding money.

You could of course just take up to a quarter of the fund as tax free cash without such adverse income tax consequences. The rest of the fund could then be drawn more slowly as you need it.

4) What are my other options?
Most people want their pension to provide them with a retirement income that will last the rest of their lives – and also the lifetimes of their partners or spouses.

There are several ways to provide an income in retirement. The conventional method is to buy an annuity – a regular income paid and guaranteed by an insurance company. But in recent years, pension drawdown – taking the income directly from the invested pension fund - has gained in popularity. And the rules about pension drawdown have been liberalised to allow a higher percentage of the fund to be taken as income, resulting in many more people choosing this route.

There are also some new products that insurance companies and other providers are launching. They aim to provide a halfway house between the safety of an annuity and the flexibility of drawdown. These can look superficially attractive but they vary considerably in design, quality and cost.

One of the advantages of drawdown is that you can draw the 25% tax-free cash from the pension gradually to provide your income in the first few years of retirement. The rest of the fund can then be left to draw on later when your income tax rate might possibly be less.

5) Are there any other changes from pensions freedom day that I should know about?
Yes. One of the unexpected outcomes of the new pension freedoms has been the opportunity to leave your pension fund free of inheritance tax to the next generation – and it will be possible for them to leave it to their successors as well, meaning pensions can be a new way for wealth to cascade down the generations of a family.

The income tax position of the pension pot you leave for the next generation will depend on your age at death. If you are under 75, it will be tax free; if you are 75 or over, it will be subject to income tax (from April 2016), where previously it was subject to 55% tax. If it's your aim to pass your pension pot on, it is important to secure your retirement income from other sources and to make sure pension nominations – which will ensure your beneficiaries receive your pensions savings - are properly set up.

The new rules also allow the possibility of making further pension contributions after starting to draw funds from a pension pot.

6) So, what should I do?
The new freedoms have led to new risks and greater complexity. Never before have people been given total freedom over how they use their pension savings. There are very real concerns that some people may fall victim to scams or simply blow their savings and be left without an adequate income in retirement.

The choices retirees will need to make can be complicated, bringing together tax, investment and financial planning skills and knowledge. The Government has recognised the difficulties that many people will now face as they approach retirement and has introduced a free guidance scheme called 'Pension Wise'. The aim is to try and stop people making some of the more obvious bad choices and to point people towards professional advisers where they need this kind of help.

We believe that many people will require professional advice on a one-off or ongoing basis to consider the various possibilities opened up by these pension freedoms. You may feel that you owe it to yourself and to your family to make the best use of the new pension and financial planning opportunities and to avoid the numerous pitfalls.

Michelle Gibbs is a chartered and certified wealth adviser for Helm Godfrey, an independent wealth and employee benefits adviser

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