In 2015, the then-chancellor, George Osborne, introduced a number of reforms that changed the way you can access your pension.
Known as “Pension Freedoms”, this legislation gave you more flexibility and control over how and when you can draw money from your retirement fund.
Osborne claimed he wanted to give pensioners “complete freedom to draw as much, or as little, of their pension pot as they want, anytime they want”.
Now, a decade later, the changes remain in place. Yet, despite having been available for 10 years, many people are still seemingly struggling to understand the choices on offer.
Indeed, research from PensionsAge reveals that 47% of UK savers remain unaware of their options at retirement, with only 27% fully understanding how Pension Freedoms work.
Continue reading to discover exactly what Pension Freedoms are and how they might affect your financial future.
Pension Freedoms are rules that give you more control over your retirement income
Before the introduction of Pension Freedoms, you could typically take a 25% tax-free withdrawal from your retirement fund, then use the rest to purchase an annuity to generate an income.
However, an annuity might not have necessarily suited your unique circumstances.
For instance, if you pass away before your annuity income exceeds the total value of your pension pot, you might not get to make the most of your retirement savings.
After their introduction, Pension Freedoms increased the number of options for savers when they reach the normal minimum pension age of 55 (rising to 57 in 2028).
They allowed you to still access the first 25% of your fund tax-free, and it seems as though people made the most of this. Royal London states that:
- 8% took it within six months of turning 55
- 26% deposited it in a bank or savings account
- 19% used it for home renovations
- 8% gave it to their loved ones.
But now, you are no longer forced to purchase an annuity with the remainder – you can withdraw as much or as little as you want, when you want it.
As well as lump sum withdrawals, another option now available is “flexi-access drawdown”. This allows you to take the income you need while keeping the rest of your fund invested. Just note that this wealth is typically taxable.
Still, this form of drawdown could allow your pension to continue growing and accumulating wealth, even after you start drawing from it.
You may want to delay withdrawing your 25% tax-free lump sum
While it can be tempting to withdraw the 25% tax-free lump sum as soon as possible, this might be unwise.
This is because doing so might reduce the overall value of your pot, effectively reducing the future potential of your retirement income.
As an example, Fidelity states that if your pension is worth £80,000, you could take £20,000 without incurring tax.
But, if you instead left this portion of your fund invested and it continued to grow at 5% a year, your pension could be worth £124,000 after 10 years.
If you took out your 25% tax-free lump sum a decade later, it would be worth £31,000 – an extra £11,000.
Of course, growth is never guaranteed, but this example shows the importance of considering timings carefully.
You aren’t required to take the full 25% in one go, either. You may find that it’s more tax-efficient to spread withdrawals over multiple tax years.
And again, any withdrawals above your Personal Allowance are taxed as income. So, strategically using your lump sum to draw from your pension in smaller amounts could help you avoid unnecessarily being forced into a higher Income Tax band.
It might be prudent to work with a professional
With so many different options available regarding drawing from your pension, it can be somewhat overwhelming to decide which strategy best suits you.
Your age, life expectancy, lifestyle goals, and the rest of your financial situation will all affect the strategy that works for your unique situation.
This is where working with a financial planner becomes valuable. Rather than dealing with the rules alone, our bespoke advice will align with your circumstances.
For example, we could help you decide to take part of your tax-free lump sum to clear any outstanding debts, while leaving the rest invested for the future.
Or, you might benefit from using flexi-access drawdown to support your day-to-day expenses, while maintaining growth on the rest of your fund.
Ultimately, Pension Freedoms legislation gives you greater choice, but that often comes with more responsibility.
With our expert guidance, you can create a retirement income strategy that takes advantage of this flexibility while ensuring your money supports your later years.
To find out more, please contact us by email at info@investmentsense.co.uk or call 0115 933 8433.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
Your pension income could also be affected by the interest rates at the time you take your benefits.
The Financial Conduct Authority does not regulate tax planning.
