Pension reforms: how the new tax rules affect youMore changes ahead of next year's pension revolution
21 July 2014
Retirees will be able to withdraw lump sum payments if they’ve bought an annuity and change the amount of income they take, the government has announced today.
In March 2014, Chancellor George Osborne announced radical changes to the way people can take an income from their pension, stating that savers could withdraw their entire savings if they wished.
Currently, retirees either buy an annuity, which pays a guaranteed income for life, or leave their money invested in an income drawdown scheme, which allows them to take a certain amount of income subject to government rules.
Mr Osborne announced that he was to scrap this, allowing people to withdraw all of their savings as they like, whenever they liked. Today, the government confirmed these changes and set new rules for the taxation of pensions in the new world of pensions freedom.
This article sets out how the reforms might affect you.
Go further: What the pension changes mean for you - an overview of the reforms announced in the Budget
How much tax will I pay if I withdraw all my pension savings in April 2015?
The first 25% of your pension can be withdrawn completely free of tax.
You’ve always been able to withdraw the remainder of your savings, but this was previously taxed at 55%.
The new reforms mean that you will be pay tax at your marginal rate - 0%, 20%, 40% or 45%. This will vary depending on how much money you withdraw.
If you withdraw less than £10,000 from your pension, you won’t pay any tax, providing that you have no other income from any other sources. If you withdraw £150,000, you will pay tax at the highest rate of 45%.
What does this actually mean for the tax I might pay?
Say you’ve got £500,000 in a pension.
• The first £125,000 can be withdrawn tax-free.
• The next £31,865 is taxed at 20%. You’d pay £6,373 in tax.
• The next £118,135 is taxed at 40%. You’d pay £47,254 in tax.
• The remaining £225,000 is taxed at 45%. You’d pay £101,250 in tax.
• In total, you’d pay £154,877 in tax, leaving you with a total lump sum of £345,123
Go further: Tax in retirement - a summary of how much tax you'll pay on your retirement income
Will my pension provider allow me to take my money in this way?
The government today has set new rules that will enable all pension scheme providers to allow you to take money from your pension scheme in the new, more flexible way.
It will also introduce new rules that allow you to switch from your current defined contribution pension scheme to another scheme whenever you like. You might do this if you wanted to buy an annuity from a pension company that wasn’t the one you had your savings with.
Under previous rules, you weren’t able to do this until you were a year away from your pre-agreed retirement age. However, the government will now allow people to switch to a new pension scheme at any point they like.
What’s happening to annuities? Are they dead now?
When Mr Osborne announced his plans to shake up pensions, he said that no-one would be forced to buy an annuity. The share prices of many annuity providers dropped dramatically, with many predicting the end of these products altogether.
However, today’s announcement changes some of the tax rules that will allow annuities to become more flexible.
The major proposals are:
1) The government will allow annuities to vary the amount of income they pay. This could allow you to take less when you start to receive the state pension, for example. You may also be also be able to take larger sums later on in your retirement, perhaps to help pay for long-term care.
2) The government will allow you to take a lump sum from an annuity. At the moment, once you buy an annuity, you get paid an income from it with no further withdrawals. New rules will allow you to take a lump sum from an annuity, provided you agree to this when you buy one.
3) The government will allow your family to be paid from your pension after you die. Guaranteed annuities pay out to your beneficiaries after you die, but this usually only lasts for 10 years after you bought the annuity. Next year, the government will make sure that your pension fund is returned to your family when you die. And your family could receive this as a lump sum, if it’s under £30,000.
Go further: Annuities explained - the pros and cons of different annuity options
What other tax changes will be introduced?
To ensure that people don’t abuse the tax system, the government has introduced some restrictions on what you can do with the pension savings you withdraw.
When you put your money into a pension, you get tax relief as an extra contribution from the government. It costs the government £22.8bn a year to do this.
However, there’s a risk that people, from age 55, could divert their salary into a pension to avoid income tax and get more tax relief, then withdraw 25% tax-free. The government say this is unfair.
Once you’ve started drawing pension using income drawdown, you will be limited to saving £10,000 a year into a pension with tax-relief. This way, the government says, people won’t be able to use the new pension flexibilities to avoid paying tax on their current earnings.
Is there anything else?
Yes. The minimum age you can take your pension is currently 55. The government has announced that this will increase to 57 in 2028.
The government has also said that the 55% tax that’s paid on your pension after you die is too high. However, it won’t make any changes to this rule until the Autumn Statement, which usually takes place in December.
What's more, the Chancellor today confirmed that pensioners will be entitled to free, impartial advice when they get flexible access to their pension pots from April 2015 onwards.
Go further: Pensioners to get free retirement advice - learn more about this announcement