Pensions: keep up with the shake-up

With only weeks to go until “the biggest pensions shake-up in history”, as it has been described, most people are still trying to get to grips with what the new rules mean for them.

Greater flexibility also means greater choice, but also greater uncertainty as to the best option. In these circumstances it becomes all the more important, for solicitors as much as for their clients, to take appropriate advice to ensure that their retirement plan is tailored to their needs.

Under the new pension freedom rules that come into effect from 6 April 2015, you will be able to cash in your entire pension fund either in stages or all at once, subject only to any limit set by the pension providers on how much you take from the plan. Money left in your pension fund will fall and rise in value depending how it is invested.

Points to ponder

If you decide to take money out, 25% of the withdrawal will be tax free, with the remaining 75% taxed as part of your income. Alternatively you can specify that you wish to withdraw only your tax free cash. But as Wesleyan, the specialist financial services provider for professionals, points out, taking a lump sum may not be the best, or easiest choice, simple and tempting though it may sound compared with shopping around for an annuity.

For one thing, Wesleyan highlights, pension providers do not have to adopt the new flexibilities, so it is essential that you check your own provider’s position if you wish to take advantage of the new pension arrangements early on, as switching providers can be a lengthy process.

Further, as explained above, depending on the size of your withdrawal you may find yourself with an additional tax charge, which could significantly impact on the amount received by a higher-rate taxpayer (and it should be considered whether the withdrawal itself would take you over the higher-rate threshold).

Then the decision has to be made, how to invest the lump sum, which brings into play the desired balance between capital growth and income, risk and reward, and the wide choice of investments available: another reason for taking specialist advice.

Although there was criticism of the rigidity of the former system, which required the pension holder to purchase an annuity with their fund, apart from the permitted withdrawal of up to 25% as a lump sum, it should still be considered whether an annuity is in fact the best option. As chartered financial planners Munro Partnership note, annuities will continue to be available and you can still use some or all of your pension fund to buy one to guarantee your income for life or for a fixed term, the income being taxable in line with your tax rate. It may continue beyond your death if you have added a pension for your spouse, a guarantee period which pays the pension for a minimum number of years, or value protection (which returns the money used to buy the annuity less any payments received).

Tax-effective vehicle

Pensions continue to be one of the most tax-effective investments available in the UK, Munro emphasise, particularly if best advantage is taken of the new options. As well as the ability to take a tax-free lump sum, personal contributions attract tax relief at your highest marginal rate, so that 20%, 40% or even 45% is effectively paid by HMRC – though tax relief above 20% is not received automatically but must be reclaimed via HMRC. Investment growth within your pension fund is free from capital gains tax.

On death, under the new rules, any money in your pension can now be left to anyone you like, not just your spouse. (The tax treatment of this money depends on whether you die before or after the age of 75, being taxable in the beneficiary’s hands in the latter case.) Money in a pension also sits outside your estate for inheritance tax purposes.

“All of your finances are connected,” Linda Gilbert, chartered financial planner at Munro sums up. “It is very difficult to make a change in one area without affecting other items, such as your cash flow, tax position or investment options.

“Receiving sound financial advice is very important, especially around retirement age, to ensure that income and capital needs are planned for in the most tax efficient manner. The new pension rules will now provide everyone with more flexibility and it will be important to ensure that your own retirement plan is tailored to your needs.”

Samantha Porter, Wesleyan’s group sales and marketing director, puts it this way: “There is no doubt that this year’s pension reforms will bring more choice for customers, which is to be welcomed. However, it’s important to make the right decisions, as after a long career lawyers will want to ensure they have sufficient income to enjoy the retirement they want. They should discuss all of the options available to them with a financial services specialist who understands their profession.

“Lawyers should not rush into any decisions over their pension savings. But they also need to establish if and when to take the right actions, which requires careful consideration of all options available to them, preferably with the support of a professional who understands the specific needs and challenges of their profession.”