The pension freedom reforms introduced by Chancellor, George Osborne, are now 2 months in and although this overhaul is still being applauded, there is a concern that some will be tripped up by the new rules and make a decision that could cost them both now and in the long run.
However, before we get into the nuts and bolts of these new freedoms, it is worth pausing to accentuate the tax breaks afforded through pension planning to individuals and employers on contributions, fund growth and at retirement. Tax relief at individuals’ highest marginal rates, corporation tax relief for employers, the ability to carry forward unused annual allowances from the previous 3 tax years just scratch the surface of the tax advantages in terms of financial and taxation planning.
Now, back to pension freedom – what does it essentially mean? It allows over-55s to take control of their own retirement savings and spend, save or invest them as they wish.
Yet, serious risks are looming, like paying far too much tax and the possibility of treating the pension fund like a cash windfall and spending the entire fund.
Unwary individuals who are either still working or about to retire could overpay tax, miscalculate their state pension entitlement or lose benefits.
Workers used to simply paying the basic rate of tax through employers might not realise that dipping too freely into their pension pot from age 55 will more than likely put them into the higher rate tax bracket.
Those on means-tested benefits should also take care about cashing in their pensions in case this makes them ineligible for state support.
Meanwhile, there is a risk that some people will overestimate their state pension and run down their pension savings before realising they are due less from the Government than anticipated. The pension freedom changes coincide with a major revamp of the state pension introducing a new flat weekly rate payment and the need to have made full NI contributions for 35 years to qualify for the maximum benefit.
There has been a great deal of anticipation and discussion about the freedom April brought in terms of being able to withdraw cash from pensions but it is imperative that people think carefully before doing this.
Many people will have spent decades building a pension or accumulating pension pots so they need to make sure it does what it is supposed to do – pay for you in retirement. The right thing to do with your pension will depend on your own circumstances but the first step is to seek independent financial advice to help understand all your options.
Pension freedom is a major sea change and the devil is in the detail and that is why it is vital that factors like taxation treatment, investment risk, morbidity, mortality and death benefits need to be considered, so that it allows for an informed decision to be made of how best to use pension saving throughout retirement.
The foregoing is meant for general guidance and please note that tax services provided by James & George Collie Financial Management Limited are not regulated by the Financial Conduct Authority.