Pension changes – will you take money out?

In April 2015, major changes to UK pensions are being introduced. Pension Wise is the government service that will provide information about what pension options you have. Today the new Pension Wise website has gone live – it’s in “beta test” mode, so it’s still under development.

Pension Wise logioApart from the government website, there will also be guidance available over the phone and face-to-face. The phone guidance will be delivered by The Pensions Advice Service and the face-to-face guidance will be delivered in selected Citizens Advice Bureaux – the first 44 CAB’s taking part in England and Wales are listed here.

Did you notice I said “guidance” not “advice”?

The new Pension Wise service will be giving “guidance” not “financial advice”. It won’t tell you what you should do, but it will talk through what your options are so you can understand the choices you may have.  It will talk about the importance of “shopping around” to make sure you get the best deal, but it won’t recommend which providers you should go to or what your pension should be invested in.

Are you affected by the pension changes?

The people immediately affected will be:

  • aged over 55, and
  • have a Defined Contribution pension pot which has not yet been used to buy an annuity.

“Defined Contribution” is one of those bits of jargon that makes pensions seem so difficult to so many people. If you have a pension where you or your employer is contributing a set amount of money each year, this is a Defined Contribution pension. It is sometimes known as a Money Purchase pension.

If your pension will be based on your salary, this is a Defined Benefit pension – these are not affected by the main pension changes in April. But if you have a Defined Benefit pension and you make extra contributions (AVCs), the AVCs are a Defined Contribution pension and the pension changes will apply to it.

The main pension changes

From April, if you are over 55 you will have the following options for the “pot” of money in your pension:

  • leave it untouched until you need the money – you can still contribute more and your pot could also grow if the investments increase in value;
  • buy an annuity – this gives you a guaranteed income. Depending on what sort you buy, it may increase with inflation and / or provide an income for your spouse if you die. Many health conditions mean that you would get an “enhanced” annuity – for example if you are a smoker, have high blood pressure, suffer from asthma etc.  You will be able to take 25% of your pot tax-free before buying an annuity;
  • get a flexible income – you can either take 25% of your whole pot tax-free at one go, or you can take smaller cash sums from the pot as you need them, and 25% of each will be tax-free;
  • take it all in cash – 25% will be tax-free.
Hardly anyone will buy a sports car with their pension pot - but many will be at risk of running out of money

Hardly anyone will buy a sports car with their pension pot – but many will be at risk of running out of money

Taking it all in cash – is that a good idea?

The advantages of taking the money may seem obvious – you get your hands on it and can spend it how you like!

And several people have told me that they are thinking of doing this because they are worried that pensions may be changed yet again in the future and if they don’t take the money now, they may not later be able to.

If you have significant debts, then this money may seem the perfect way to clear them, but read Pension Changes and Debt if you want to know more about this.

But let me list some of the “downsides” of taking money from your pension aged 55, so you can decide which might affect you:

  • if you are taking more than 25%, you will have to pay tax on the rest as though it was income. If you are working, then this extra “income” may push you into a higher tax bracket, so you could be paying 40% or 45% tax on it. If instead you took less, or none, out now, then you could take it later when your income  may be lower so the tax man gets less of it;
  • if you get any means-tested benefits, suddenly getting a lump sum may reduce the benefits you get;
  • if you decide you want 25% tax free aged 55 and buy an annuity with the rest because you want a guaranteed income, then by buying an annuity aged 55 you will get a smaller income. It would have been bigger if you had bought the annuity  later when you are retired. If you don’t need the money know, it could be better to wait;
  • if you spend the money now, you may not have enough money when you later retire.

Many people underestimate how long they will live, and even if you know intellectually that you are likely to live to over 85, there is still a natural tendency to think more about the next ten or twenty years. The old pension arrangements “protected” people from taking foolish decisions and spending all their money too soon. The new arrangements mean that you have to think hard about this sort of risk.

Of course if you have a good final salary pension and just a small defined contribution pot, it might be a good idea for you to take it all early. But not many people will be in this fortunate position.

Don’t rush into this decision

Unless you are very clear about what you want to do, the best thing may be to take some time to think about it. Do your research and find out what all your current pension pots are worth – this is the essential first step in taking a good decision. Then go and talk to Pension Wise – although this isn’t live yet, you can register your interest here.

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