Should you cash in your pension?
It's no surprise that the rule change has whetted savers' appetites. For the first time, they can do what they like with their money. "It's created a sense of ownership that people haven't had before," remarks Murray Smith, a director at wealth manager, Mattioli Woods. "Pensions are no longer seen as a complicated locked box."
But just because you can start taking money out of your pension from the age of 55, it does not necessarily follow that you should.
This is because what stands between you and your cruise (or whatever you plan to spend the money on) could be a very sizeable tax bill, as Fiona Tait, business development manager at Royal London, explains.
"Although you can have the money, it will be subject to tax - so if you have £30,000 in your pension, you can be sure you won't get £30,000."
Under the new 'uncrystallised pension fund lump sum' rules, the first 25% of every cash withdrawal is paid tax-free but you must pay tax on the remainder at your marginal rate of tax.
This means that three-quarters of your money will be taxed at the highest rate of tax you pay (even if you are only just over the threshold). It's also important to know that this money will be added to your income for the year meaning that it could bump you into a higher tax bracket.
Jonathan Watts-Lay, a director at Wealth at Work, warns: "Somebody earning £25,000 and paying basic-rate tax, cashing in a £30,000 pension in one go would become a higher-rate taxpayer overnight."
Making matters worse, experts are also warning the way in which your money is taxed could prove an administrative nightmare. This is because your pension will be treated as income and taxed under PAYE. "PAYE works well for regular income but it doesn't work well for lump sums," says Andrew Tully, pensions technical director at MGM Advantage.
As such, your withdrawal is likely to be subject to emergency tax. HMRC is likely to assume this is your new income and could continue taxing you at a higher rate in the following months. You would then need to either reclaim this money yourself or rely on the taxman to settle the money when he balances his books. "It's a big can of worms," warns Tully.
The tax can at least be reduced by withdrawing funds regularly to prevent you being bumped up a tax bracket and being forced into paying a higher rate than necessary.
Taking your tax-free cash
Of course, tax shouldn't be a problem if you only want to take the 25% tax-free cash that was available under the old rules (known as your pension commencement lump sum).
However, because the first 25% of any withdrawal is now paid tax-free, if you want to take all of your tax- free cash, you'll have to effectively cash the whole lot in – or as pension bods would say, 'crystallise' your pension, thereby forcing you to make a decision about what to do with the remaining money.
So if you don't want to take the money and pay tax on it, you'll either need to move it into drawdown or buy an annuity.
But a big income tax bill isn't the only reason to keep your money in your pension. At the end of last year, George Osborne announced new rules that allow savers to pass on pensions to their loved ones tax-free when they die. This replaced a previous death tax of 55% (itself a reduction on the 82% tax levied until 2011).
Smith says the value of this change should not be underestimated - particularly if you are concerned about leaving an inheritance to your loved ones and the level of tax they will pay when you die.
"For the first time ever, we have proper inheritance of pension assets. This is the biggest change I've seen in my 20-year career," Smith adds.
Under the new rules, pension savers with money invested can pass on their savings entirely free of tax if they die before the age of 75. If they die on or after their 75th birthday, there will be no tax on the transfer of capital – tax would only be liable be once the recipient started to take an income from it.
Leave your pension to who you like
Another significant change is that savers are no longer confined to leaving their pension to a spouse or dependent child. Now you can leave your pension to whomever you like.
"I have wealthy clients who are bypassing their children and the pension fund is going to the grandchildren," says Smith.
And because inherited wealth does not contribute towards the lifetime allowance (the amount of money you are limited to having in your pension), this can provide your beneficiaries with a very real boost to their retirement savings.
Smith says this could lead to a marked change in the way people spend their money. "People will run down those assets that are subject to inheritance tax first. There is no point taking money out of your pension unless you need to."
For these reasons, the experts are agreed there is no point taking money out of your pension just for the sake of it.
Adrian Walker, retirement planning manager at Old Mutual, says that if you are taking your money out of an environment where it is sheltered from tax to one where it will not be, you need to have good reason. "Identify what you need the money for," he suggests.
There is no point, for example, just taking your money out of your pension and putting it in a low-paying deposit account, says Tait.
She explains: "There is a mentality of wanting access and control of your money but you can now treat your pension as another instant-access account."
If you still have debts, however, it could be cost-effective to use pension money to pay them off as it will save you interest and reduce pressure on your monthly bills.
Likewise, if your pension is only enough to generate a few pounds a week, you may get more value by taking the money. "If a pension is so small that it can't create a meaningful income, it may be worth taking the cash and using it for something meaningful," suggests Tait.
However, if your plan is to spend it on 'wants' rather than 'needs' – that cruise to kickstart your retirement, a new kitchen or car - then you need to make sure you can afford it; as the more money you take now, the lower the income your remaining fund will be able to generate.
Do I have enough money?
Ask yourself "do you have enough money to live on and have you overestimated the amount of state pension you'll receive," suggests Alan Higham, retirement director at Fidelity.
Bear in mind, too, that there is every chance you will live longer than you anticipate, warns Tully. "Our research shows that men tend to underestimate their life expectancy by five to eight years and women by 10 years, which is a significant amount."
He adds: "It is not easy to manage money with so many unknowns such as how long you'll live."
Finally, before you dip into your money you should also think about any other unintended consequences. Would taking the money mean giving up a guaranteed annuity rate, for example? These are available on many older pension schemes and can provide a level of income that far outstrips the levels you could achieve on the open market.
Or if you are only on a modest income, will this extra cash affect your entitlement to means-tested benefits?
The ability to take cash out of your pension is a fantastic boon that gives you more choices and control over the money you have worked hard to save.
It can give your retirement a great boost or help solve a financial problem but before you sign on the dotted line make sure you understand the impact it will have now and in the future.
"People need to understand the consequences at the time of doing it," warns Tully, "not two or three years down the line."
Boom time looms for pension scammers
More over-55s are being targeted by criminal pension liberation schemes, according to the deVere Group. Chief executive Nigel Green warns: "Since the pension freedoms and flexibilities were announced, we've seen a month-on-month increase in clients saying they've been cold-called or emailed from so called 'pension liberation' firms, many of which it can be assumed are unauthorised or operating illegally."
The schemes offer the chance to 'cash in your pension', 'pension loans' or 'free pension reviews' and require savers to move their money out of their current pension into a new scheme run by the pension liberation company. Once the company has your money, it can take huge levels of commission and invest it as it chooses – often in worthless property developments – or the company could simply take your money and run.
Green adds: "I would urge anyone who is contacted to liberate their pension to be extra cautious, not to be rushed into making a decision they might regret, and to seek professional independent advice before proceeding."
Do you think you could get a better return from property?
A third of pension savers aged between 45 and 64 would like to use some or all of their pension cash to buy a rental property, according to Direct Line 4 Business.
Providing a regular income stream along with the potential for capital growth, buy to let appears to be a viable alternative to an annuity or income drawdown plan. However, aside from the fact that it involves putting all of your eggs into one basket, experts are also warning that it could leave you with a huge tax bill.
Fiona Tait, business development manager at Royal London, warns: "You could pay tax to get your money out, then you've got stamp duty to pay when you buy the property, tax on your rental income and a possible capital gains bill. Then if you need to get your hands on your money, it isn't instant access as it would be in your pension." She adds: "People don't appreciate the real value of their pension - they are very tax-efficient."
Find out everything you need to know about the new pension freedoms and how to plan ahead for the retirement you deserve with the new issue of How to Retire in Style. The magazine is available to buy now from all leading newsagents, priced at £4.99. It can also be ordered online here for £6 including postage and packing.
A hugely unpopular tax paid on property and share purchases. Stamp duty on property is levied at 1% for purchases over £125,000 (£250,000 for first-time buyers) which then moves up at a tiered rate. For property between £125k and £250k you pay 1%, then 3% from £250k up to £500k and then 4% from £500k to £1m and then 5% for properties over £1m. But unlike income tax, which is “tiered” and different rates kick in at different levels, stamp duty is a “slab” tax where you pay the rate on the whole purchase price of the property. On shares, stamp duty is charged at a flat rate of 0.5% on all share purchases. Figures correct as of May 2011.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
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.
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.