In the 2014 Budget, the UK Government announced a number of significant changes to the way in which defined contribution pensions can be managed. The requirement to purchase an annuity has been removed meaning that people now have greater flexibility in accessing their pension pots. People who are 55 or over can now choose to take all their pension pot as a lump sum, but is this the most tax-effective way to financially manage retirement?
The new rules mean that withdrawals from a pension will be treated as income and the tax due on what is withdrawn will depend on the amount of other income received during that tax year. Previously, full withdrawal would have resulted in being taxed at 55%.
It has always been possible to take 25% of a pension in a single tax-free lump sum, but most people then bought an annuity with the rest of the money. Even though the rules of any particular pension scheme have to be examined in detail, it may now be possible for people to draw down a number of smaller lump sums and, in each case, 25% of the sum will be tax free.
Although, originally, this change was announced to apply only to people with ‘defined contribution’ pensions (otherwise known as a ‘money purchase’ scheme), this has now been extended to include some people who have a ‘defined benefit’ scheme (where there is a promise of a certain level of pension in retirement which is linked to a person’s salary).
In practice, these new rules mean that someone with a pension pot of around £40,000 (the average for people with “defined contribution” in the UK) could still take the total amount on retirement, and have no other income. From the £40,000, £10,000 would be tax-free and then the remaining £30,000 would be liable for tax, which would be around £4,000.
However, by taking the £40,000 in stages at £10,000 per annum, there would be an annual tax-free sum of £2,500, with the remaining £7,500 liable for tax. The personal allowance is presently at £10,000 and so, without receiving any additional income (e.g. state pension), this would be potentially tax-free.
With regards to the myth ‘It’s Best to Withdraw all My Pension’, and whether it is a Workplace Pension or Private Pension, careful planning with the assistance of an independent pension adviser is recommended to guarantee the best tax-efficient way of accessing and managing a pension pot after April 2015.
Further information is available on the DPT Financial Solutions website and to speak with Dan Thomas please call 01443 229589 or by email on firstname.lastname@example.org or via our website.