With retirement lasting as long as 30 years or more, making the right financial decision is extremely important. We outline 8 things you need to know about your pension and retirement rules.
1. Tax relief remains robust
The amount of tax relief you earn on pension contributions remains the same and is very generous, particularly for high earners. When you contribute to your pension pot, the Government will return any income tax paid on it. This means a £1 gross contribution costs a basic-rate taxpayer 80p, a higher-rate taxpayer 60p and an additional-rate taxpayer just 55p.
Pension freedoms have given retirees added flexibility
2. Your annual allowance has fallen
Generous tax relief means many of us are putting as much as we can into our pensions. But don’t get caught out by the annual allowance. Back in 2010 you could save as much as £255,000 into your pension each year, but the annual allowance has been dramatically slashed since then.
Now the annual allowance is £40,000; pay in more than that and you’ll face punitive charges and won’t receive any tax relief on the additional amount. For high earners, the allowance falls even further; it starts to taper off for those earning more than £150,000 a year, falling to £10,000 for anyone with an income above £210,000.
3. You can carry forward old allowances
If you’re worried you may pay more into your pension than the annual allowance this year, don’t panic. You are allowed to carry over unused allowance from the previous three tax years, starting with the earliest year, but cannot receive tax relieve on contributions in excess of your earnings in a tax year.
4. Your lifetime allowance has dropped
As well as putting a cap on how much you can save into your pension each year, the Government has also limited how big your entire pension pot can be. This used to be £1.25 million, but it has now fallen to just £1 million with the new tax year.
If your pension grows to be bigger than £1 million, you’ll pay a hefty lifetime-allowance charge when you access it. This amounts to a 55 per cent tax if you withdraw it as a lump sum and 25 per cent if you draw it as an income, plus the normal income tax due.
5. Protection is vital
There are several ways this year to protect your pension if it is, or is likely to become, worth more than the lifetime allowance. You could opt for fixed protection, which locks in the old £1.25 million lifetime allowance, but you would not ever be able to add any more contributions to your pension (apart from in very limited circumstances). This could be a good choice if you have a large pension pot that is likely to exceed the £1 million lifetime allowance.
Alternatively, you could opt for individual protection if your pension pot is worth at least £1 million already. This protects your pot up to a maximum of £1.25 million. Whilst this protection allows you to keep making contributions, when you take your benefits you’ll pay tax on any savings above your protected lifetime allowance.
6. You now have greater freedom
Last year, new pension freedoms revolutionised the way in which we all access our retirement savings. You can’t touch your pension until you’re 55, but then you are free to do with it what you want. You could withdraw the lot and blow it on fast cars and holidays; you could leave it invested and draw an income from it; or you could buy an annuity with it. It is entirely up to you.
April 2017 will also see the introduction of the new Lifetime ISA, designed specifically for those aged 18-40. People in this age group will be able to contribute up to £4,000 annually, up to their 50th birthday, and receive a 25 per cent bonus from the Government at the end of each tax year. These funds can be used tax-free to buy a first home worth up to £450,000 or for any other purpose after you hit 60. Withdrawing the funds prior to 60 will mean you lose the 25 per cent bonus and will incur a 5 per cent charge.
7. Income tax still applies
You’re allowed to take 25 per cent of your pension pot tax-free. You can either take the entire 25 per cent at once or take it in small amounts over many years. Beyond that 25 per cent, any more money taken from your pension, either as a lump sum or as income, will have income tax deducted from it. The amount of income tax you pay will depend on what tax bracket you fall into.
When you die, any money left in your pension can be passed on to your beneficiaries and will not be liable to inheritance tax. If you die before you are 75 and your beneficiaries take the pension benefits within two years then there is no income tax to pay either; if you are over 75, then it will be taxed at your beneficiaries’ highest income-tax rate.
8. Professional advice is important
Pensions are complicated beasts and getting professional advice can make a huge difference to the level of income you enjoy in retirement. Research by Fidelity International has found that 40 per per cent of enquiries to financial advisers are now related to retirement income, making it by far the biggest financial concern.
"With retirement lasting as long as 30 years or more, making the right financial decision is extremely important," says John Clougherty at Fidelity International. "Pension freedoms have given retirees added flexibility with their pension savings, but there is a clear need for expert help in such a significant, yet complex, area."
- Thanks to Elliott Silk, head of employee benefits at Sanlam.
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