Ten things you will – or will not – be able to do under the new pension rules

There is just over a month to go before the new pension freedoms are introduced. Those with defined contribution pension schemes, also known as money purchase plans, will be able to dip into their retirement savings or blow the entire pot from the age of 55.

The scale of the changes, announced less than a year ago, has left many people confused. We tackle 10 myths about what the freedoms mean for you.

1 Insurers will let me use my pension like a bank account from April

There’s nothing in the pension legislation forcing insurers to apply the new rules to existing policies. Indeed, some insurers, particularly those that are no longer interested in attracting new customers, may not offer any of the pension freedoms at all, while others simply have not been able to update their systems in time. As a result, 6 April could be a bit of an anti-climax.

Alan Higham, retirement director at Fidelity, the investment firm, said: “Your pension scheme or company can stick to the original deal of offering you just an annuity. You may well have to move to a new pension provider if you want to access your savings earlier.”

And bear in mind that transferring between providers is not always a quick process. You could have to wait a few weeks, or even a few months, to dip into your pot.

2 I can cash in my pension pot tax-free

There are growing fears that pensioners do not realise that only 25% of your pot is available to be taken tax-free. The rest will be taxed as income as it’s withdrawn from your pot, incurring rates of 20%, 40% or even 45%. Crucially, this means taking out a large amount of your pension – or even cashing in the whole pot – to pay for a home extension or a new property could push you into one of these higher tax brackets, resulting in a large tax bill.

Using an extreme example, someone cashing in a £400,000 pension pot could take £100,000 as the 25% tax-free lump sum but the remaining £300,000 would be taxable as income. Income above £150,000 a year is taxed at 45%, while the remaining amount would be subject to 40% and 20% tax rates, as anyone taking an income of more than £121,200 also loses their personal allowance. So the resulting tax bill would be £121,143, around 30% of the original pot, according to figures by Aviva, the insurance firm.

The solution? Make smaller withdrawals over a number of years to avoid incurring higher rates of tax.

3 Annuities are dead

It is unlikely that annuities will disappear completely. Indeed, there are reasons to believe they may return even stronger than ever.

David Smith, director, financial planning at wealth manager Tilney BestInvest, said: “Despite much comment to the contrary, annuities are likely to remain a mainstay of the retirement income market. Indeed, if at some point we see long-term interest rates rise and therefore annuity rates rise, it’s not inconceivable that annuities could one day return to their glory days.”

Andrew Tulley, from MGM Advantage, a pensions firm, said: “Blended solutions, offering the benefits of drawdown and annuity within one wrapper, are likely to be introduced into the market and become popular.”

4 After April, I must cash in my pot, buy an annuity or go into drawdown

Not so. Under the new rules, you don’t need to do anything with your pension. There is no requirement to buy an annuity or go into drawdown. You can cash in some of your pot or all of it, but you don’t have to.

You could choose to keep all your money with your existing pension firm and take occasional withdrawals, known as uncrystallised fund pension lump sums (Ufpls, or “ufplus” as some in the industry describe it). Under this option, a quarter of each withdrawal is tax-fee, while the rest will be taxed at your marginal income tax rate. So on a £100,000 pot, you could take out £10,000, allocate £2,500 of this as a tax-free lump sum and pay income tax on the rest.

However, it’s unlikely that all pension providers will give you unfettered access to your pension for free under Ufpls. Insurers have not publicly declared how much they will charge for dipping into your pot, but some charge up to £300 to make “ad-hoc” withdrawals from income drawdown plans. Adviser Hargreaves Lansdown recently became the first pension provider to reveal its prices, announcing that ad-hoc withdrawals from its pensions would be free. Others have yet to declare their hand.

5 I don’t need to worry about running out of money

Even if you plan carefully, you could still be in danger of running out of money because it is common to underestimate how long you will live for in retirement. Men approaching retirement age typically underestimate it by an average of five years, while woman assume their life expectancy is 10 years earlier than it really is. Indeed, the number of people expected to live to 100 will rise from 14,000 in 2013 to 114,000 in 2037, according to the Office for National Statistics.

Use pension calculators online to work out how your pension funds will grow over time if you take out various levels of income.

6 My pension pot is subject to inheritance tax

Pensions are not included in your estate for inheritance tax purposes in most cases and this won’t change. But one of the biggest changes being introduced in April will be the scrapping of the “death tax” on pension funds passed down to your family after you die.

Previously, if you’d started drawing an income from your pension funds, the remaining funds could be passed on to your spouse tax-free, but if you left them to your adult children they were taxed at 55% in most circumstances. From April, they will be passed on tax-free if you die before the age of 75, or taxed at your children’s marginal rate if you die after the age of 75, so potentially at the basic rate of 20%.

This makes it a potentially attractive way to pass on wealth. Danny Cox, of adviser Hargreaves Lansdown, said: “Changes to the tax treatment of pensions on death should have investors revisiting their wills, inheritance tax and estate plans.”

You also need to make sure you tell your pension provider now who will inherit your pension if you die.

7 I’ve got a final salary pension, so I can’t take advantage of the reforms

People with private sector (company) final salary schemes, known in the trade as defined benefit, are not allowed to take advantage of the new rules to dip into their retirement savings. But they can transfer these retirements pot into a personal pension and subsequently access their funds.

There has been speculation that this could be particularly useful for those who want to pass on some of their pension wealth to their children. But be warned. When you want to transfer a final salary pension, you need to ask for a transfer value from your scheme provider. These can often be up to 40% less than the total value of your retirement savings, so you would be giving up potentially hundreds of thousands of pounds in pension benefits, plus the security of inflation protection. It’s essential to get financial advice before a decision.

The transfer rules are different for those in the public sector. Public sector schemes, such as the NHS, civil service and teachers pensions, will not allow transfers into defined contribution schemes after April.

8 You can take out funds from your pension then pay them in again, doubling up on tax relief

This is partly true, but the government has taken steps to prevent the system being abused. We can currently pay in £40,000 a year into a pension. However, anyone who takes advantage of the new rules to dip into their pension will see the maximum they can pay into a scheme (and benefit from tax relief) drop to £10,000 a year, or 100% of their salary, whichever is lower. What’s more, you cannot carry forward unused allowances either (which let you use your annual allowance from three previous years if you haven’t used them already).

Alan Higham said: “Higher-rate taxpayers should consider this carefully, for example those made redundant who decide to use their pension temporarily while finding a new job.”

9 The government protects you from dodgy pension investments

You’ve heard of the Financial Conduct Authority, so you assume that it prevents unscrupulous firms from persuading you to invest in bogus investments, yes? Unfortunately not. Unregulated Collective Investment Schemes, from timber plantations to Cypriot property developments, are expected to boom after 6 April, but don’t be fooled into investing in anything that sounds suspicious or too good to be true.

10 The government is providing free retirement advice

In his budget speech last year, George Osborne also told the Commons: “And we’re going to introduce a new guarantee, enforced by law, that everyone who retires on these defined contribution pensions will be offered free, impartial, face-to-face advice on how to get the most from the choices they will now have.”

Later, the government clarified that what the chancellor actually meant to say was “guidance”. Giving someone financial advice – specific suggestions about how to arrange their finances tailored to their situation – is a strictly regulated service, with various protections in place for consumers if you do it badly. Guidance describes more general, non-specific information about personal finance. Such as this article.

So if you were hoping the government was paying for a series of financial advice sessions at your retirement, that isn’t the case; you’ll have to pay for these yourself. You can, however, sign up to a guidance session (known as Pension Wise) with Citizens Advice, where someone will run you through the options available to you. They just won’t tell you what to do next.

THE TAX TRAP

Pensioners dipping into their pension pot for the first time after 6 April could find much more of it has been taken by the taxman than they might have expected.

HM Revenue and Customs will treat the first one-off withdrawal as if it will happen every month, applying an emergency “month 1” tax code 1060L M1.

John Lawson, head of retirement at Aviva, said: “This means that someone would initially receive just one-twelfth of the normal personal allowance of £10,600, one-twelfth of the basic rate tax band of £31,785, and so on, to set against the whole taxable payment. This calculation methodology will result in effective tax rates of over 30% in many cases, even although the person’s normal top rate of tax is 20%.”

This extra tax will need to be claimed back, either by filling out an HMRC repayment form - a P50 form if your only other source of income is the state pension, or a P53 if you have other sources of income. Otherwise pensioners can wait until the end of the year, when HMRC will refund any overpayment.

However, experts warn it could be difficult for HMRC to keep up. Lawson added: “It will be interesting to see how HMRC copes and there could be chaos.”

HMRC has said that emergency taxes do not need to be applied where a tax code is already held for an individual and the provider’s systems can separately report the “flexibly accessed” element. It said: “In the unlikely event that the tax code is not up-to-date, we will electronically provide the pension scheme with a tax code to operate against the next payment to make a refund of any overpaid tax.”

However, many pension providers will not have the right tax codes for savers, making withdrawals for the first time. Lawson said: “The vast majority of withdrawals will be caught by the month 1 basis. We must apply month 1 in most cases even where we know someone’s tax code.”