New rules that will allow savers to take more cash from their pensions came into force on Thursday (27 March).
The changes - which were announced in the Budget earlier last week - will allow more savers with small pensions to take their pots as cash and enable investors using drawdown arrangements to take a higher income.
As of 27 March, what are known as the 'trivial commutation rules' have been changed to allow savers with pensions worth up to £30,000 to take the money as cash, up from a previous level of £18,000. Alternatively they will be able to take three funds worth up to £10,000 as cash. Under the old rules only two pots worth up to £2,000 could be cashed in.
Of the money you cash in, 25% can be taken tax-free with tax charged on the remainder at your marginal rate.
Improvements to the system
Tom McPhail, head of pensions research at Hargreaves Lansdown, said he had been campaigning for this change for years, which will spare savers from buying poor-value annuities that could only pay a matter of pounds every week.
"Reforming the small pots rule will help to unlock improvements right across the pension system. Small investors will get their money back; insurers will be able to sell better value annuities to large customers and it will help to minimise auto-enrolment opt-outs," he explained.
The income drawdown rules have also been relaxed. The level of income investors can take has been increased from 120% to what they would have been able to achieve with an equivalent annuity has been increased to 150%. This will be available to all new drawdown customers as of today, however existing customers will have to wait until their policy anniversary before they can increase their level of income.
However McPhail warns investors shouldn't be tempted to take too big an income. He warned: “It is important for investors to remember that new income limits haven’t changed the fundamental principles of investing. If you draw the maximum income, you will probably run down your pension fund. Our default recommendation for an investor looking to take a sustainable, rising real income is to invest in a good spread of predominantly equity based funds and to take the ‘natural yield’ from the investments as income.”
These limits do not apply to investors in flexible drawdown. However, the minimum pension income they need to demonstrate to qualify for this type of arrangement has been reduced from £20,000 to £12,000.
Both sets of changes are only short term. The government is currently consulting on making pensions even more flexible, by allowing savers to take their entire pension pot as cash and invest it how they choose. This already happens in Australia and removes the need for retirees to buy an annuity. The Treasury expects this to come into force in April 2015.
While this flexibility has been widely welcomed it does make for some difficult choices for savers and investors - particularly those who are approaching retirement.
McPhail added: "If in doubt, investors should review their current retirement income plans. For many people an annuity will still be the right answer however we expect insurance companies to be forced to work a bit harder for investors' money. Drawdown offers a useful short term option to pay out some income if needed at retirement while investors work out what to do next."