Osborne’s pension revolution

Ed Bowsher looks at what the chancellor's far-reaching pension reforms could mean for your retirement pot.

The more we learn about George Osborne's pension reforms, the more it becomes obvious that they amount to a pensions revolution.

Earlier this week, the chancellor published his Taxation of Pensions Bill, which gives us more clarity on what is being proposed. In particular, he highlighted the fact that the rules governing the 25% tax-free lump sum will be much less stringent from next April.

Let's imagine that you have a £100,000 pension pot and you've not made any withdrawals until now. Under the current rules, you can take out £25,000 right now as a tax-free lump sum.

Once you've done that, you can use the remaining £75,000 to buy an annuity that will give you an income for life. Or you could use the £75,000 to set up an income-drawdown policy where you can continue to withdraw money while the remainder of your pot stays invested.

The first set of reforms, announced in March, made the rules on income drawdown much more flexible.

However, some further rule changes, which won't be implemented until April 2015, mean you won't have to withdraw the £25,000 tax-free lump sum in one go. Instead, you can take your tax-free money in separate tranches.

To see how this works, let's assume you still haven't touched your pension fund by April 2015, and you want to withdraw £10,000. You will be able to withdraw that sum as an Uncrystallised Pension Fund Lump Sum (UPFLS).

You'd receive £2,500 tax free and you'd have to pay income tax at your marginal rate for the remaining £7,500. So if you're already a higher-rate taxpayer, you'll have to pay 40% income tax on the remaining £7,500 in your lump sum.But if your overall income is smaller, you'll only have to pay 20% income tax or no tax in some circumstances.

This means that with careful planning, you could pay far less tax on your pension over your lifetime than under the current system.

What's more, if there is anything left in the pot when you die, your inheritors will be better protected from tax on the money you leave them.

If you die before you reach 75, they won't have to pay any income tax on the remaining funds they get from your pension. However, if you die at an older age, your beneficiaries will still have to pay some income tax when they withdraw cash.

The flexibility that new retirees are now gaining is very welcome. Let's just hope that everybody can resist the temptation to blow their pension pots in a hurry.

Recommended

How much money will you need to comfortably retire on?
Pensions

How much money will you need to comfortably retire on?

New research shows how much you might need to live comfortable life after you stop working.
25 Oct 2021
Should you buy an electric car?
Personal finance

Should you buy an electric car?

Battery-electric cars aren’t cheap to buy, but they cost less to run. Alex Rankine runs the figures.
25 Oct 2021
Retirement income
Sponsored

Retirement income

Anyone approaching retirement – and even those some way off – need to understand how to create a sustainable and secure income for the future. It is v…
19 Oct 2021
Post-Covid travel is now less testing as the rules get simpler
Personal finance

Post-Covid travel is now less testing as the rules get simpler

With the scrapping of the amber and green travel lists, the rules governing re-entry to the UK have finally been simplified.
15 Oct 2021

Most Popular

Properties for sale for around £1m
Houses for sale

Properties for sale for around £1m

From a stone-built farmhouse in the Snowdonia National Park, to a Victorian terraced house close to London’s Regent’s Canal, eight of the best propert…
15 Oct 2021
How to invest as we move to a hydrogen economy
Energy

How to invest as we move to a hydrogen economy

The government has started to roll out its plans for switching us over from fossil fuels to hydrogen and renewable energy. Should investors buy in? St…
8 Oct 2021
Emerging markets: the Brics never lived up to their promise – but is now the time to buy?
Emerging markets

Emerging markets: the Brics never lived up to their promise – but is now the time to buy?

Twenty years ago hopes were high for Brazil, Russia, India and China – the “Brics” emerging-market economies. But only China has beaten expectations. …
18 Oct 2021