Pension Freedoms Explained: Options To Taking Your Money

Pension Freedoms Explained Drawing

Estimated reading time: 8 minutes

Pension freedoms are the rules that give retirement savers choices about spending their money once they are 55 years old.

Pension Freedom Options

Pension freedoms give savers six options for taking their retirement cash, such as taking 100% out, annuity and others

The rules fundamentally changed the way you could cash in from your pension.

To make the best of pension freedoms, you need to understand your options and how the rules work.

Chancellor George Osborne ripped up the retirement rule book and started with pension freedoms on April 6, 2015.

He aimed to scrap stifling rules that left some struggling to make ends meet even though they had tens of thousands of pounds locked away in a pension.

The changes were a huge success. The latest HM Revenue & Customs data shows an average of 305,000 retirement savers take £2.1 billion from their pensions every quarter.

What Are Your Retirement Pension Freedoms?

Financial experts shroud pension freedoms in jargon, like flumps and benefit crystallisation events, but you don’t need to know this stuff to make sensible decisions about cashing in your money.

Pension freedoms boil down into a few simple options:

FreedomOne-off incomeRegular incomeGuaranteed incomeCan you run out of cash?
Buy an annuityNoYesYesNo
Flexible drawdownNoYesNoYes
Cash in the whole fundYesNoNoYes
Take cash when you wantNoYesNoYes

Don’t forget that you:

  • Can’t take any cash until you are 55 years old
  • Still get 25 per cent of your fund tax-free whichever option you choose
  • Can pick-and-mix your pension freedoms, for example, cashing in part of your savings and taking the rest as a regular income
  • The freedoms apply to ‘defined contribution’ pensions, such as personal pensions, workplace pensions, and the Qualifying Recognised Overseas Pension Scheme (QROPS). Not all workplace schemes or QROPS offer the full range of options

Buying An Annuity

Before pension freedoms, most savers invested in an annuity to give an income during retirement.

Annuities offer a guaranteed income that increases with the cost of living for life but are considered expensive.

Since the advent of pension freedoms, savers have spurned the annuity market, with many preferring to manage their own money.

You never run out of money with an annuity, as monthly income comes with a lifetime guarantee.

Drawing Down Your Pension

Drawing down a pension has become the most popular way to manage retirement money.

With drawdown, the pension fund stays invested in the stock market and continues to grow.

But savers can draw cash out as they wish. That includes regular payments each month or one-off cash withdrawals to fund a holiday or new car.

Pension drawdown suits savers with other sources of income but who need the flexibility to take different amounts of cash when they want.

Cashing In Your Pension In One Go

Pension freedoms let you take all your savings in one go but think about the tax implications before you do.

The first 25 per cent of the fund comes tax-free. After that, the pension fund balance is added to your other income and taxed at your highest rate.

Flexible drawdown can considerably lessen the cash you receive. Instead, think about spreading the drawdowns across more than one tax year.

Taking Regular Lump Sums

Pension savers can take lump sums in two ways:

  • Payments at regular intervals, like £500 on the first day of the month
  • Irregular payments, like £500 on January 1 and £650 on July 1

You can dip into the fund when you need the money. Each withdrawal is 25 per cent tax-free, but the remaining balance is taxed at your standard tax rate.

Tax Dilemma For Retirement Savers

HMRC taxes pension withdrawals as payroll. The problem is if you take £15,000 from a pension, tax rules consider this as an annual payment of £120,000 and will tax all the money less the tax-free 25 per cent lump sum.

Some people massively overpay tax because of the way HMRC treats pension withdrawals.

You can reclaim the overpayment, but the process takes a month or so and sometimes, retirement savers must take more money than they need to account for tax.

What Happens To My Pension When I Die?

When you die, what happens to the money you have not spent depends on your age and the type of pension you have.

  • If you have a defined contribution pension with an investment value reflecting how the stock market rises and falls, you can leave the unspent fund to your family or friends. If you are under 75 years old when you die, they inherit the fund tax-free, but if you are older than 75, they must pay income tax on their good fortune.
  • If you have a joint-life annuity, your partner can continue to receive monthly payments, but the payments stop if the annuity was on your life alone.
  • If you have a final salary workplace pension, you do not have a pot to pass on. However, some workplace schemes pay a pension to the surviving spouse.

Contributing To A Pension In Drawdown

Once you have drawdown some cash from a pension, the Money Purchase Annual Allowance (MPAA) comes into play.

The MPAA limits the amount you can pay into a pension to £4,000 in a tax year from April 6, 2017.

If you want the full tax benefits of a pension, you must not save more than the lifetime allowance.

The current lifetime allowance is £1,073,100 frozen until at least 2025.

Any pension savings over the lifetime allowance level are taxed.

Pension Freedom Age Changes

The age retirement savers can access their pension cash is going up by two years, a minister has warned.

From 2028, the age limit will rise from 55 to 57 years old as the law changes ‘in due course’.

Raising the pension freedom age was first signalled in 2014, but no legislation has been forthcoming, leaving many to wonder if the change would go ahead.

Who is affected by raising the pension freedom age?

Any hike in the pension freedom age to 57 in 2028 affects anyone with a defined contribution personal pension born after January 1, 1971.

Those most at risk from the financial consequences are those born in the early part of the year who may have to delay their retirement plans for two years or more.

Media reports suggest that raising the age limit follows lobbying from the Association of British Insurers, a trade body for the pension industry, who fear the current limit is too low and savers risk emptying their pension pots too quickly as longevity increases.

A Treasury spokesperson said: “The announcement of the minimum pension age rise to age 57 in 2014 set out the timetable for this change well in advance to enable people to make financial plans, and we will announce next steps in due course.”

Pension Freedoms Explained FAQ’s

Below are some of the frequently asked questions relating to pension freedoms.

What does pension freedom mean?

Pension freedoms allow retirement savers aged 55 and over the chance to take 25 per cent of their pension tax-free and the rest as they wish – in a single lump sum, as regular income or by taking money when they need to or a mix of all three.

Do all pensions qualify for pension freedoms?

No. Pension freedoms are for direct contribution pensions, such as personal pensions, SIPPs, or workplace pensions. Final salary, state pensions and public service pensions are excluded because they are not funded in the same way and don’t have an investment value.

Can I take all the money in my pension?

Yes. But don’t forget you will pay tax on 75 per cent of the pot, and if you have a large fund, this may push you into a higher tax bracket, so you should think about phasing the withdrawals to minimise the tax you pay.

Who can advise about what to do?

The government has set up the free Money Advice Service and Pension Wise to give retirement advice, or you can consult an IFA. The free services can explain your options without telling you what to do, while an IFA will do both for a fee.

If you have a pension pot of more than £30,000, taking advice before withdrawing any money is compulsory.

How do I take money from my pension?

To withdraw pension freedom cash from your pension, speak to your provider or financial adviser.

They will give you a form to complete and then transfer the money. The processing time varies but takes an average of 10 to 14 working days.

A firm says they can unlock my pension before I reach 55, is this right?

No. Beware of any adviser offering a free pension review or a pension unlocking scheme, they are probably scammers, especially if you found out about them from a cold-call. The law does not allow early access to pension savings to anyone under 55 years old unless they are seriously ill.

My provider does not allow flexi-access, but I want to withdraw some pension cash

You cannot withdraw money from you pension before the age the scheme allows unless you are seriously ill.

If you want to switch from a pension scheme to one offering flexi-access, you can discuss a pension transfer with an IFA.

You can find further related information and articles following the links below.

Questions or Comments

After reading Pension Freedoms Explained, we love getting feedback from our readers if you have any questions or want to comment. Please do not hesitate to send us a message on this site or our social media.

Leave a comment