Should I take my pension as cash?
Rather than converting the money into an income with an annuity or income drawdown plan, it's now possible to cash in pension holdings worth up to £30,000. And, from April 2015, all restrictions will be removed and savers will be free to cash the lot in if they choose. As pensions minister Steve Webb put it, you're free to use your retirement savings to buy a Lamborghini.
The announcement, which was made in the 2014 budget, unleashed a groundswell of concern from many in the pensions business – what if savers really did blow the lot on cruises and sports cars and ended up reliant on the state?
Michael Ward, managing director of comparison site Payingtoomuch.com, warned: "If an annuity does not get purchased at retirement, our worry is that even the most sensible person will be tempted to spend more of their pension cash than they planned. And as they will have no guaranteed income for life, which an annuity does provide, we could see a generation relying on benefits after their pots have run dry."
Research from LV= suggests the doomsayers may have a point. The insurer's research revealed that the average new retiree already goes on a £33,000 spending spree during the first five years of their retirement, splashing out on foreign holidays, electronic goods, going to the theatre and eating out. So, if savers can cash in as much as they like is there a risk that the temptation to spend could be increased?
However exciting the prospect of a ‘no-strings' attached lump sum might be, there is a very significant catch that all savers planning on cashing in their pensions must factor in and that is tax.
After your 25% tax-free cash allowance, all withdrawals will count towards your income for that year – so depending on the size of your fund, there is a very good chance you'll be pushed up into a higher tax bracket for that year and lose a sizeable chunk of hard-earned savings to the taxman.
As a result, Ray Chinn, head of pensions and investments at LV=, says: "I can hardly see Lamborghini sales booming." He adds: "It's an attractive idea, but as soon as people realise how much money will go to the taxman they'll reconsider."
Paying off debts
However, that's not to say the new flexibility won't suit some people – particularly those who only have a small amount in their pension as Laith Khalaf, head of corporate research at Hargreaves Lansdown explains: "If you're in a situation, say, where you have a lot of debt, it may make sense to take cash – particularly if you are paying a high level of interest."
For these savers, paying off an expensive credit card debt or personal loan could be far more economical over the long term than exchanging the pension for a small annuity that may only pay out a few pounds a week and, as Chinn notes, for these savers "the tax hit is not going to be as big".
Topping up tax-free cash
Alternatively, some people may use the facility to support any significant expenditure in retirement and not necessarily taking the lot. "Some people may take more than 25% tax free cash - if they have a lifetime goal they want to achieve," adds Chinn.
Cutting your tax bill
Jonathan Watts-Lay, a director at Wealth At Work, says that before anyone draws cash down from their pension, they need to have a plan for it. "If you are going to take all, or a big chunk of your cash, you need to ask yourself what you are going to do with it. If you are taking money out of a tax free environment into one that is taxed, is there any point?"
Khalaf adds that those savers that do have a specific plan for their money can at least reduce the tax sting by taking the money out gradually. "If you take cash you don't want to bump yourself up into another tax bracket and if that's likely you may want to stagger your withdrawals over a few years," he adds.
An alternative to an annuity, income drawdown (also known as an unsecured pension) allows you to take income from your pension fund while the fund remains invested and so continues to benefit from any fund growth. The drawdown of income has to be calculated carefully as taking too much income could exhaust the pension fund so experts say the annual drawdown must not exceed what the assets would normally yield in an average year. The invested pension fund could also be hit by market turbulence and the value of the assets could fall.
Used by the holder to buy goods and services, credit cards also have a monthly or annual spending limit, which may be raised or lowered depending on the creditworthiness of the cardholder. But unlike charge cards, borrowers aren’t forced to pay the balance off in full every month and, as long as they make a stated minimum payment, can carry a balance from one month to the next, generating compound interest. As the issuing company is effectively giving you a short-term loan, most credit cards have variable and relatively high interest rates. Allowing the interest to compound for too long may result in dire financial straits.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.