Pension Advice Made Simple

Understanding the risks under the new pension rules

The media is full of coverage about the overhaul of the rules governing access to pensions that come into effect this month.

Most of the coverage focuses on the many benefits that the new system will provide: primarily, the fact that people who withdraw their pension under the new system will have more freedom than ever before, in deciding how they will use their pension pot. However it was recently highlighted that the new system also presents a number of risks.

The team here at Unlock My Pension have poured over the new rules and regulations governing access to pensions. This post points out some of the key risks that should be kept in mind when following the new rules.

Is there a knock on impact of cash withdrawals?

Under the new rules if you have a ‘defined contribution’ pension pots (the kind where what you get as a pension income depends on what you have paid into it over the years), you will have more freedom than ever before to decide how to use your pension. Historically you would have been quite limited in terms of how you could use your pension: most people would decide to buy an income for the rest of their lives via an annuity. However under this month’s new rules, you have options:

  • You could withdraw the entire value of your pension pot now, and use the cash yourself; or
  • You could withdraw 25% tax free as a lump sum, and leave the rest invested.

These options do give greater choice, but they also have new consequences. If you decide to withdraw the more than 25% of your pension now as a cash sum (perhaps to try and pay off existing debts), this will be subject to a higher rate of income tax. The tax that you could be liable to pay can be as much as 60%, which may well exhaust a significant proportion of your pension pot.

Another consequence of withdrawing any monies from your pension pot, is that it may affect your entitlement to welfare benefits. It was recently announced by the Department for Work and Pensions that where people are receiving any kind of means-tested benefit e.g. Housing Benefit or Income Support, this will be adjusted according to the level of pension income they are receiving. This is because pensions, for the purposes of the DWC are a form of ‘income’, which may mean that your benefit entitlement is reduced.

Getting rid of an annuity: a good or bad decision?

The new rules mean that you are no longer limited to buying an annuity with your pension pot to provide an income. However many people will have already done so. Under the new regime, if you have already purchased an annuity you will be able to sell this back with a view to receiving a cash lump sum.

The Government understands that many people may decide to opt to retain their annuity, but also wants to extend the option to everyone as annuity rates have become less favourable in recent years and some may feel that they have not received a good deal. Alternatively, given recent economic hardship, many people may want to sell their annuity and use the cash to help members of the family. The difficulty however is that in receiving a cash lump sum, you will automatically be placed into a higher income tax bracket. As a result you may receive a lesser cash payment than your originally expected. Worse still, the payment that you ultimately receive may not reach the value you expected leaving you with a greatly reduced pension pot.

The pension pot: is it an investment or not?

The new regime throws into sharp light the many investment options that are available to people when withdrawing their pension.

Some may be considering withdrawing their pension pot – in small or large quantities – with a view to placing it into what they may think as a more lucrative investment e.g. property. It is important to keep in mind that while pensions are not free of taxation, they do enjoy more tax protection than non-pension investments: pensions are in themselves a kind of investment. There will be capital gains tax to consider as well as the issue of dividends to consider with non-pension investments e.g. property. The fact of the matter is that non-pension investment may not always be as predictable as you would like, meaning that you may ultimately end up with lesser money than if you had not looked to invest the fund.

The overhaul of pension rules in the UK has at its core, the principle of freedom of choice. The UK Government is allowing people to have more freedom in how they utilise their hard earned savings. However it is important to note that these new freedoms, while exciting also have their own consequences. These should be considered carefully before making any drastic changes to your pension pot.

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