Know Your Pension

This year saw the most radical changes to private pensions for a generation. We asked consumer champion Martin Lewis for his advice…

This is about how you use your pension savings. As always you can take a quarter of it as a tax-free lump sum. Yet for decades most people have effectively needed to use the remainder of the money to buy an annuity – a product that pays you an income each year until you die.

Now anyone aged 55 and over can take the whole amount as a lump sum, paying no tax on the first 25% and the rest taxed as if it were a salary at their income tax rate.

Does it apply to all types of pension? No, we’re only really talking private pensions where you and/or your employer saved up a pot of cash for retirement. These are known as ‘defined contribution’ or ‘money purchase’ pensions. It doesn’t apply to the state pension, nor in the main part does it apply to pensions where what you’re paid is a proportion of your final salary – known as ‘defined benefit’ pensions. There are ways to convert these final salary pensions into cash, but don’t do it without genuine independent financial advice.

Is it worth taking out my pot as soon as I can? Usually not. If you’re in your 50s or early 60s you’re probably still working towards retirement and should be focusing on putting yourself in a position to have enough income when you do retire.

Yet if I want to I can just take out all the cash? If you choose to yes, but remember only 25% of it is tax-free. The rest is taxed at your current income tax rate like salary, and if you take a huge whack, just like if you earn more, some of it will push you into the higher tax bracket.

If I don’t want to take it all out what can I do?

Option 1: Leave it in your pension for when you need it. Then each time you withdraw, 25% of that is tax free.

Option 2: Take 25% tax free, then buy a flexible income drawdown product. This is a product you buy to keep the rest invested so it can still grow, but you can use it to take income when needed.

Option 3: Take 25% tax free, then buy an annuity. This gives you a guaranteed income each year for the rest of your life.

I thought annuities were as dead as a dodo’s granny? Annuities are a decent concept, you get the security of knowing how much you can spend each year, and that it’ll last for the rest of your life. The problem is the rates have been poor, and 60% of people got them from their pension provider rather than checking for better deals. Yet done right it can be a useful option for security of income for life.

Martin Lewis OBE is a television presenter. He created the website

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