The pension big bang

George Osborne announced a massive pension reform in his Budget.

In this video, Ed Bowsher looks at what the ‘pension big bang’ is all about, and who it affects.

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Hi. In this video I'm going to look at George Osborne's massive changes to the pension system. Now, here at MoneyWeek we think they're really good news. We think they give people a lot more freedom and control over their pensions, and that's very positive. We're actually calling all these changes the ‘pension big bang’. So in this video I'm going to take a look and see what the big bang actually is and, just as important, I'm going to look at who is affected by these pension changes.

So let's start by looking at who is affected.Basically, it's anyone who's still working who has a defined contribution pension. These are sometimes known as ‘DC pensions’ or ‘money purchase pensions’. The idea behind that is that through your working life – or some of your working life – you're making contributions into a pension scheme, and every time you make a contribution the tax man gives you some tax relief, which just boosts it up some more. With some decent investment growth, hopefully by the time you retire you've got a decent sized pension pot that can then provide an income when you're no longer working.

For many people it's not just the employee who contributes to the pension pot. The employer will contribute too. So I might have a pension scheme where, say, I'm paying in 5% of my salary each month and my employer matches that and pays in 5% too, and then the tax man pays in a bit more on top of that. Some employers will pay more than 5%, and some less than 5%. Just depends on what the employer decides to do.

The good news is that more and more people are now getting employer contributions thanks to some previous government changes called ‘auto-enrolment’. So if you've got a DC pension scheme where the employer is willing to make contributions, make sure you sign up and hopefully by the time your retire you'll have built a decent sized pension pot.

Now if you don't have a defined contribution pension, you may have a defined benefit pension; also known as a DB pension or a ‘final salary pension’. Here, the basic idea is that when you retire you might get, say, 30% of your final salary as a pension and then that pension will rise in line with inflation until you die. Now, if you've got one of these final salary pensions, it's really good news for you. Well done, you're lucky. You won't be affected by the pension big bang. You really don't need to worry about this anymore. You can switch off, go away, and do something else more interesting.

But, if you've got the DC pension scheme, please do keep watching. As I said a minute ago, hopefully if you've made these contributions into a DC scheme and the employer has contributed too, you should have a decent sized pot when you come to retire. The big question then is, what do you do with that pot?

Until recently you had very little control. You basically had to use most of the money to buy an annuity from an insurance company. So if you have £100,000, you pay the insurance company, it then pays you a guaranteed income for life which might be say £5,000 a year. The big plus point here is you have an income for life, guaranteed until you die. The big minus points are you don't have much flexibility and also annuity rates in recent years have been very disappointing. People have been really fed up when they discovered how low their annuity actually is.

Well, with the new changes you've now got lots more freedom and lots of alternative options you can choose from. So under the new rules you'll almost certainly be able to take all of your money out of your pot from April 2015. Huge flexibility if you can do that, and actually some people can even take all the money out now, right now, under the new rules.

You just take out that full £100,000 if that was your pot. That's great in many ways. You've now got control and you can decide how to invest your money and get a good income in your retirement. Or indeed you could take all the money out right now, go on a round-the-world cruise or spend it on a Lamborghini. Or, of course, you could mix and match and use some of the money to spend right now and invest some of the money for the long term, or you could even spend some of the money now, invest some of the money now and then use the remainder in ten years’ time to buy an annuity when you're heading towards the end of your life.

Now the thing is, when you make this decision about what to do with pension pot there's lots of different issues you need to consider. Ideally you want to get the maximum return possible from your pension pot. You want to get as much money out and actually spend that money as you can. You want to keep your tax bill as low as possible, but you also need to remember that your retirement could last for a long time and you still want to have some income if you're still alive when you're 95 or 100.

If you want to keep the tax bill as low as possible, one thing you can do is take out what's called the 25% tax-free lump sum. So take that money out when you retire. You don't have to pay any tax. That's fantastic. But, if you take out the remaining 75% in one go, you may end up paying more tax than is necessary. So if you want to keep the tax bill down, you may want to spread out the period over which you pull out money from your pot.

If you want to get the maximum return, you may want to leave some of your pot invested in the stock market so you get more growth. Your pot grows to a larger size and you get a bigger return. On the other hand, if you're thinking about living, having a retirement that lasts for 30 or 35 years, you may need to consider putting at least some of your pot into an annuity. It's complicated stuff. Lots of things to consider. I can't go through it all in one video, but don't worry.

Here at MoneyWeek we've put together a free email series that will take you through all the different options that you could choose with your pension pots and we also take you through all the different issues that you should think about. So if you want to sign up for this email series, we have a pension big bang sign-up page on the MoneyWeek site. If you just look below this video right now, you'll see a link to that pension big bang landing page. Click on the link, go through on that page, you can give us your email address and then we'll then send you our free email series on the pension big bang.

It's primarily aimed at people who have just retired or are about to retire in the next year or two. Hopefully it'll really make things less complex. You'll now be less confused. In fact, you won't be confused at all and you won't be scared at all either and you can then make the right decision. So please do sign up for the series if you fancy it. It's completely free. There's no obligation. I think you'll find it really interesting and worthwhile. I'll be back with another video soon, so until then good luck with your investing.

Click here to get your FREE ‘Pensions Survival Guide’, and find out everything you need to know about the new pensions system.

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  • mikeT

    If you manage your own pension, you must know the risks -and this does require some knowledge of bond duration. Unfortunately, one of the most widely-used portfolio analysers – Morning Star – is not as complete as it looks (despite being used by huge investment platforms like Fidelity). Though it returns a “portfolio duration”, it excludes many popular “fund of funds” and even (perplexingly) some pure bond funds. Closer inspection shows the % of the portfolio analysed but it is very easy to miss this and be misled. In any case, where do you now go to get the duration of the excluded funds?
    The data to analyse these “missing” durations is available, apparently – it just seems that MS does not regard it a priority to “drill down” into it! I do, which is why I’ve posted this and similar at various times on MW. Without a large reader response to present to MS, I suspect nothing will change!

  • MikeD


    Your article says that if you have a DB pension then go back to sleep! Is that really good advice?

    My DB fund was a Section 32 buyout as the company had closed down many years ago. I felt that neither my own or the widow’s pension seemed to be a fair reflection of the fund value, and there was no tax-free cash option.

    I asked for a transfer value and moved the funds to a personal pension. I was lucky with the timing, the fund has grown by 13% in < two years and I now have supreme flexibility in how I use the fund.

    One particularly attractive feature was that should I die before crystallising my pension the whole of the fund would be available to my family, not just the miserly fixed amount of 50% of the annual pension. If I crystallise smaller segments of the fund the uncrystallised funds are then available.

    Perhaps these options are not open to everyone but I am glad it was for me.


  • Pensiion60

    The state pension is supposed to underpin all these investment changes, but in fact is withering away with the Flat Rate Pension 2016.

    The wife loses around £25,000 of payout for 6 years from 2013 (beginning of loss of payout from 60) and probably more from the changes after 2016.

    Widows cease being able to inherit the state pension from 2016.

    The ring fenced NI Fund has been full for decades, not needing top up from tax, nor can be emptied by government by law. So the raise in retirement age (state pension payout is available whilst remaining in work) has not saved one penny in tax.

    See all the loses coming to the state pension, especially to the wife:

    Be careful with your pension nest egg. There is no law since 1993 that guarantees pension payout.

  • Carl Whelan

    Mike D, I have a deferred (DB) pension valued at £120k that only pays a refund of contributions – £17.5k – upon my death! In the process of moving it to my current workplace scheme that pays out the full pot should I die before retirement…