2 The overhaul of the pension system will signiﬁcantly impact your retirement planning, opening up a whole new world of ﬂexibility over how you spend, save and invest your pension. To help you get to grips with the changes and to ensure that you make the most of your ﬁnances during retirement, we have created a short guide highlighting the key factors that could impact how you access your pension savings, now and in the future. Our guide will help answer the following: 1. Who can take advantage of the new pension reforms? 2. How will the pension reforms work? 3. What are the tax implications? 4. What does the end of the death tax charges mean for me? 5. How can I take advantage of the new pension reforms? 6. What if I am already in retirement? 7. Who can help me make the right choice? Who can take advantage of the new pension reforms? From the age of 55, individuals with a deﬁned contribution pension, also known as a money purchase scheme, will gain unfettered access to their pension savings.
3 Individuals in the private sector or in a funded public sector scheme will still be able to transfer from a deﬁned beneﬁt pension scheme to a deﬁned contribution scheme to beneﬁt from the changes. Those in unfunded public sector schemes will not be able to transfer. How will the pension reforms work? As a result of the past pension system, most people would use their pension pot to either provide an income for life in the form of an annuity or to draw an income direct from their retirement savings. However, income drawdown has usually only been available to individuals with bigger pension pots. This means that around 400,000 people a year would use their pension savings to purchase an annuity. But this is all about to change! You will now be able to cash in as much of your pension pot as and when you like, without the requirement of purchasing an annuity. When withdrawing cash from your pension, you will still receive 25% of the lump sum tax-free, but the remainder will now be taxed at your marginal rate.
4 What are the tax implications? As mentioned previously, any withdrawals from your pension fund, minus a 25% tax free lump sum, will be added to your taxable income for that period and taxed at your marginal rate. For example, John has a pension pot valued at 250,000. He has no other sources of taxable income in 2015/16. He has a number of options if he wishes to use ﬂexi-access drawdown (FAD) to access his pension savings. Firstly, the less tax-eﬃcient option is to crystallise the whole fund via FAD then take 250,000 as a lump sum. If John decides to withdraw his whole pension, he will receive a 25% tax-free lump sum of 62,500. The remaining 187,500 will then be taxed as income. The personal allowance reduces by 1 for every 2 of income over 100,000, to a minimum of nil. This means that John will lose his personal allowance for this year. 25% tax free cash 62,500 Taxable lump sum 187, ,000 Income tax: 31,785 x 20% ( 6,357) 118,215 x 40% ( 47,286) 37,500 x 45% ( 16,875) 70,518 Net amount 179,482 70,518 / 187,500 x 100 = 37.60% tax paid
5 By withdrawing a pension fund worth 250,000 in one lump sum, John will pay a total of 70,518 in tax, leaving him with a total of 179,482. To avoid eroding his pension savings, John s second and more tax-eﬃcient option could be to use FAD to take his full tax-free cash entitlement immediately and a tax-eﬃcient income when necessary. This means John would receive 62,500 tax-free and the remaining 187,500 would stay invested. If John does need further income throughout the 2015/16 tax year, he could use his personal allowance to withdraw up to 10,600 without any liability to income tax. Please note that if an emergency tax code is applied, the taxation could be diﬀerent to the example given. As highlighted above, withdrawing large sums from your pension or withdrawing it in one go could severely eat into the potential returns that you require in order to generate a decent income for life. It is also important to remember that pensions can now help shelter your savings from Inheritance Tax. What does the end of the death tax charges mean for me? As part of the pension reforms, the government has abolished the 55% pensions death tax. This means if you re under the age of 75 when you die and you have a ﬂexi-access drawdown contract, your pension can now be passed on to anybody free of tax, whether it is taken as a
6 lump sum or an income. This also includes situations where the pension has already entered drawdown. If you have a ﬂexi-access drawdown contract and you re 75 or over when you die, beneﬁciaries will only pay their marginal rate of income tax on any income drawn, or 45% if the pension is taken as a lump sum. There will also be no limit on how much of the pension fund can be accessed at any one time. Previously, a pension pot could only be passed to a dependant. However, the rules now mean that anyone can be nominated as a beneﬁciary. The changes to death tax now mean that you will be able to build up the value of your pension pot secure in the knowledge that any unused savings will be passed to beneﬁciaries in a tax-eﬃcient method when you die. How can I take advantage of the new pension reforms? The reason so many restrictions on pensions have existed historically is to ensure our money doesn t run out, so with the possibility of twenty or thirty years of retirement ahead, making the right decision with your retirement pot is crucial. With the shackles of pension rules loosened, individuals will now be able to explore the following avenues:
7 Lump sum: You can now take your entire pension as a lump sum. 25% of the payment will be tax free and the remainder will be subject to income tax at your marginal rate. When considering this avenue, you will need to be aware of the possible tax implications if you are still working. Annuity: An insurance product that swaps your pension fund for a guaranteed regular income for the rest of your life. Although the government has removed the requirement to purchase an annuity and provided those already in retirement with the opportunity to sell their existing annuity in 2016, this form of retirement product will still be available. Flexi-access drawdown: This allows you to withdraw money from your pension pot as and when you need it. If you have vital home improvements you need to make or you have plans to travel, you can withdraw money to fund your retirement and leave the rest invested and sheltered from Inheritance Tax. You will also need to be aware of the possible tax implications when reviewing this avenue. It is important to remember that if taxable income is withdrawn from your pension fund using the new freedoms, you will be subject to a reduced annual allowance of 10,000, instead of the current annual allowance of 40,000. If you only take the tax-free cash, the 40,000 allowance remains.
8 What if I am already in retirement? The Chancellor has announced that the government will extend its pension freedoms to those who have already purchased an annuity. From April 2016, the government will remove the restrictions on selling existing annuities to allow pensioners to sell the income they receive from their annuity. If you decide to sell your annuity, you will be taxed at your marginal rate. If you are currently in capped drawdown, you have a maximum level of income that you can take from you pension each year, which is reviewed every three years until you are 75 and annually thereafter. Under the new reforms, depending on your pension provider, you can continue taking capped drawdown or move to the new ﬂexi-access drawdown, which will allow you to withdraw unlimited income from your pension savings. Alternatively, if you are already in ﬂexible drawdown, you will automatically move to ﬂexi-access drawdown.
9 Who can help me make the right choice? With greater access to pensions comes greater responsibility and the sweeping reforms signal the need for more holistic ﬁnancial planning. Research has found that ﬁnancial advisers can help retirees increase their retirement income by nearly 50%.* As an Independent Chartered Financial Planning ﬁrm, our qualiﬁed Directors, Alex Pegley and Chris Moseley are ideally placed to help you take the necessary steps to navigate the new pension system, maximise the tax advantages and provide an outcome that meets your speciﬁc retirement goals. If you re approaching retirement and you would like to take advantage of the new pension reforms, organise your FREE no-obligation Pension Review with our specialist team today on *Old Mutual Wealth 2014
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