The government's new pension freedoms, effective from Easter Monday 2015, allow individuals with Defined Contribution (DC) schemes to access their pension pots freely from age 55 (57 from 2028), subject to tax. However, experts warn of potential pitfalls, including large tax bills and the risk of running out of money without proper advice.
Under the changes, 25% of a pension pot can be taken as a tax-free lump sum, or smaller amounts can be withdrawn with the first 25% tax-free each time. Any amount above this allowance is taxed as income, with rates reaching 40% or more if total income exceeds £42,386 (2015-16). Those with income over £100,000 may lose their personal allowance, incurring even higher charges.
For those who die before age 75, the pension pot can be passed on tax-free. After 75, beneficiaries face a 45% tax on lump sums (down from 55%), though the government is considering reducing this to the marginal income tax rate from April 2016. Income drawn from an inherited pot is taxed at the beneficiary's marginal rate.
The reforms also affect annuities. While many may opt for income drawdown instead, annuities remain a viable option for some. A consultation is underway on allowing second-hand annuities to be sold for cash from April 2016, but experts caution that sellers may struggle to get a good price.
From April 2016, the lifetime allowance for pension savings will be reduced from £1.25m to £1m, rising with inflation from April 2018. This change is expected to affect only wealthy individuals. Those with Defined Benefit (DB) pensions may be able to transfer to DC schemes, but should consider the loss of inflation proofing and spousal benefits.
