We all get used to receiving a regular salary, and the relative security that comes with it. Suddenly realising you will have to provide for yourself, in retirement, leaves you wondering about how you will use your pension. A pension doesn’t really come with a manual; or if it did, you may have understandably lost the paperwork several years ago.
Until recently, the keys to your pension were largely locked away, with restrictive access to the majority of the pot. That’s all changed for defined contribution pension scheme holders, thanks to the pension freedoms introduced in April 2015. Under the new rules, you can celebrate turning 55 by being granted full access to your pension pot.
This minimum age of 55 will rise to 57 in 2028 and will then rise in line with any increase of the state pension age; but the principle will be broadly the same. For most people, they can start to use their pension long before they actually plan to retire. Having the key to the door offers a wide range of temptations and considerations, and it’s important to tread carefully.
Don’t forget why you have been saving into a pension in the first place…
…to fund your retirement, or at least to partly fund your retirement. According to Office of National Statistics average life expectancy figures, a 65-year-old man in 2014 can expect to live until 2032 and a woman until 2034. That’s a long time to rely on your pension.
Rashly spending it at the age of 55 – when, ultimately, you don’t need this money because you’re still working – could be looked back upon with deep regret.
However, the new rules could make pensions a more attractive proposition…
If you have built up a certain level of savings and investments, and would be prepared to commit them until you turn 55, there could be major benefits to placing this money inside a pension wrapper – even if you don’t want to use this money for retirement.
This is because you will benefit from tax relief, which would be worth at least 20% if not higher (it depends on your income tax status). So for every £80 you pay into a pension, you would receive £100 in your pension pot. Keep in mind your annual allowance limit.
Despite what you might have read, pensions are not ATM machines
There has been a false perception created in the media that you can access your pension in the same way you withdraw money from a bank account or cash machine. It isn’t that simple, and you could receive a nasty shock if you withdraw too much, too soon.
You know those ATM machines that charge you a fee for making a withdrawal? Well, imagine if that fee was 20% of the amount you asked to take out? Or worse still, 45%?
Only 25% of your pension fund is tax-free to withdraw, the rest is treated as income and subject to income tax. In other words, you’ll pay at least 20% tax, but might pay twice that amount if you go over a certain threshold – and that can be easily done.
Paying income tax on pension withdrawals is often unavoidable. You really should manage your withdrawals carefully, to ensure they are tax-efficient. Financial advice is strongly recommended.
The tax treatment of your investments depends on your individual circumstances and prevailing legislation, both of which may change in the future.