The 2014 Budget, presented by the coalition government announced a fundamental reform to the UK pension system. With effect from the 6th April 2015, new ‘pension freedom’ rules were introduced which means that anyone aged over 55, with pension savings, built up under a defined contribution (DC) scheme, has been given much more flexibility around how they can access their pension fund savings.
For example, some retirees might want the security of an annuity (which gives them an income for life), while others may wish to take out all their savings as a lump sum. There is also an ‘income drawdown’ option for those do not want to purchase an annuity or withdraw all their savings in one go. An overview of the pension freedom rules is summarised below.
In September 2020, the government confirmed that with effect from 2028, it was increasing the minimum age at which individuals could access their pension fund from 55 to 57. The exact date in 2028 has yet to be announced.
Pension freedom rules
Before the 6th April 2015, anyone approaching retirement had very little control over what they could do with their pension savings.
While you could shop around to get the best annuity rates, the end result was the same. You signed over your pension fund to a pension provider and in return you received a guaranteed income for life.
When you died, any money left in the fund went to the provider and not your descendants. The system was considered inefficient, inflexible and unfair and eventually lead to the introduction of new pension freedom rules.
The pension freedom rules mean that you are not required to buy an annuity, but you have the option to do so, if you wish for example to have the security of having a guaranteed income for the rest of your life. Any money left in the fund when you die can be passed on to your nominated beneficiaries.
Pension freedom rules also mean that you are not obliged to withdraw money from your pension fund when you reach the retirement age that you agreed with your pension provider. Your savings can be left invested in the fund until you decide when you want to access it.
To understand the range of options available under the pension freedom rules please follow the link.
What happens to your pension when you die?
Under the pension freedom rules, you are now free to pass on your fund when you die without your beneficiaries incurring a large tax bill. Under the previous regime, a tax charge of 55% of the fund amount would have been charged to your estate.
The new rules state that if you die before the age of 75 your beneficiaries can inherit the fund tax-free; and if you are over 75 and your beneficiaries want to inherit your pension as one lump-sum they will pay tax at 45%. If, instead, they want to take money from the pension fund as income, then they will pay tax at their usual income tax rates.
What if you are in a defined benefit scheme?
The pension freedom rules were created with holders of personal pension schemes in mind. If you are in a defined benefit (or final salary) pension scheme, you will not automatically be allowed to take all of your pension fund.
However, some employers are offering to buy employees out of their workplace pension schemes in return for a one-off, lump sum settlement. This would then allow you to take advantage of the pension freedom rules applicable to defined contribution schemes.
Any employee contemplating taking up an employer’s buy-out offer should take advice from a regulated independent financial adviser, to understand the risk implications of doing so. Plus, you could also lose entitlement to valuable benefits.
Consider obtaining independent financial advice
For information on choosing a financial adviser, please follow the link.
