More than four million people have been warned that they will have to wait up
to five years to get their hands on their pensions if they don’t take action
fast. A quick decision is needed because the Government is increasing the
minimum age that you can take pension benefits, from 50 to 55, on April 6
next year.
It is a stark choice for the one million people who will reach 50 in the next
12 months. Overnight they will lose access to their pension until 2015.
The jump in the minimum retirement age also means that more than three million
people aged between 50 and 54 need to decide whether they would benefit from
taking their pension now or sit back and wait.
Martin Tilley, of Dentons Pensions Management, says: “Many people have no idea
that they will not be able to take their pension from age 50 in less than a
year’s time and they should be considering whether they need to draw it
early. That does not mean an end to pension saving. There is no need to draw
on all their funds, and they can still top up their funds and make
contributions.”
Even if you take only small amounts, this could provide some much needed
flexibility at a time when money worries remain the biggest concern for many
families.
For high earners the decision has been given fresh urgency by the Budget. The
Chancellor revealed that from April 2011 those earning £150,000 or more will
suffer a cut in tax relief on pension contributions. Many will conclude that
it is simply not worth saving from that date and will decide that they would
rather unlock their pension savings now, while they still can.
Raj Mody, of PricewaterhouseCoopers, the accountant, says: “For many people it
will be a lifestyle decision. A tax-free lump sum taken now could, for
example, be used to pay off your mortgage. Do nothing and you could be
signing away the ability to get your hands on that cash for the next five
years.”
The change affects anyone born between April 6, 1955, and April 6, 1960. Since
the pensions regime was overhauled in 2006 it has been possible to get your
hands on tax-free cash and convert some of your pension into an income while
continuing to work and save. However, the options open to you depend on the
type of scheme that you are in.
Anyone saving in a personal or stakeholder pension should have the most
flexibility.
The maximum that you can take from a pension as tax-free cash is 25 per cent
of the value of your whole fund — £25,000 of a £100,000 pension pot. The
remaining 75 per cent must be used to buy an annuity or move into an
income-drawdown plan. Drawdown, officially called an “unsecured pension”,
allows you to leave your fund invested with the option of drawing an income
— or not — each year.
The good news for those who do not plan to retire and who have suffered a big
drop in the value of their pension funds because of the stock market turmoil
is that you do not have to take your benefits all in one go.
As an absolute minimum, you must take the tax-free cash portion of the pension
you are cashing in. If you move the rest into a drawdown plan, you can take
an income of up to 120 per cent of the return that you would have received
from an annuity, but you do not have to draw an income if you do not need
it.
Here we explain the options for pension savers in different schemes.
Personal pensions
Most of these schemes, including self-invested personal pensions (Sipps),
offer phased retirement. Your fund is divided up, usually into 1,000 slices.
Each piece is effectively a separate pension scheme and you can take 25 per
cent of each slice as a tax-free lump sum and use the remainder to purchase
an annuity or income-drawdown plan.
For example, a 50-year-old with a £100,000 pension could take the whole amount
— £25,000 as tax-free cash and £75,000 as an annuity or income-drawdown.
Alternatively, he or she could cash in 500 of the 1,000 slices, taking only
£50,000 in total, with £12,500 as a tax-free lump sum.
Some older personal pension contracts do not offer phased retirement and the
only way to take advantage is to transfer to a scheme that does. But think
carefully about what you are giving up and how much it will cost to
transfer.
Company pensions
The options for those in company schemes is more limited because most do not
offer full flexibility. Only about one in ten schemes allows employees to
take a tax-free lump sum before retirement. Phased retirement is rarely
offered either.
The only option for many will be to move to a personal pension. However, most
experts do not recommend this. It can be costly and the transfer value
offered may not be good value. Your employer may also refuse to pay into a
personal scheme, meaning that you will miss out on future contributions.
Even if your employer does offer full flexibility, think carefully before
going ahead. If you are in a personal pension or money-purchase plan and
take your tax-free cash and an income at 50, long before you intend to
retire, you could miss out on ten to fifteen years of growth on that money.
If you are in a final-salary plan, you will lose income if you take it before
the stated retirement age. Most schemes require you to give up 4 per cent to
6 per cent of income for every year you take all, or part, of your pension
early. So if you take income at 50, rather than the stated 60, your income
could be reduced by up to 60 per cent.
Risks
There are other factors that could make taking your pension now less
palatable.
Drawdown can be risky. In most cases there is no need to take any more
investment risk than you would in a normal pension. If you are in a personal
pension, you should be able to simply transfer funds and other assets in
your existing pension fund into the drawdown scheme.
However, there is an an added danger if you are drawing an income. If your
fund does not grow quickly enough to cover the income withdrawals and
charges, it will start to shrink, making it harder to keep up the income
payments without depleting the fund. Charges in a drawdown plan also tend to
be higher than those of a standard personal pension.
Paying your tax-free lump sum back into your pension can be a way to rebuild
fund value. By reinvesting it you earn extra tax relief, boosting the fund
by thousands of pounds.
For example, a higher-rate taxpayer with a £50,000 pension fund takes a
£12,500 tax-free lump sum. He or she pays it back into the pension and
immediately receives 20 per cent tax relief of £2,500 on the contribution.
This will boost the pension pot by £15,000, to £52,500.
Take care, though, because the Government has introduced special rules to
ensure that the system is not abused. Under convoluted rules, you will be
deemed to be “recycling” if you take more than £17,500 as a tax-free lump
sum and if your pension contributions jump markedly after you take the cash.
If caught out, you will be hit by a 55 per cent tax charge.
Retiring at 50
The rise in the retirement age was pushed forward by the Government as part of
a package of measures to encourage people to work longer. This was presented
as a postive move, providing greater options for older people. For many
people, however, retiring in their early-fifties remains a long-cherished
dream.
For most, that dream will never become a reality because the majority cannot
afford it. Figures from Friends Provident, the insurance company, show that
someone contributing £300 a month to a pension from the age of 35 to 50
would have to survive on retirement income of £4,148 a year, assuming that
he or she bought an annuity. If the same person carried on saving to 60, the
income would be £10,987, and at 65 it would be £17,223. These figures
assume annual growth of 6 per cent after charges and a 4 per cent annuity
rate.
Case study: tax-free cash to reduce debt
Joss Harwood, 51, pictured with her partner, Tony Conner, 43, is considering
taking tax-free cash before next April’s deadline and moving the rest of her
retirement fund into an unsecured pension.
The cash would be handy as a means to pay down her mortgage — and if she does
not take the money in the next year, it will be locked away for another
four.
As co-owners of Eldon Financial Planning, an independent financial adviser,
the couple are more aware than most of the consequences of delaying. Ms
Harwood says: “This is an issue that is slipping out of the back door
because it has not been well publicised.
“I am not planning to retire yet and don’t need the pension income, but the
cash would reduce the mortgage. I could then use the monthly savings to
build up my pension fund again.”
New rules for drawing the state pension
The Government is raising the state retirement age for women to 65 from April
6, but the good news is that thousands more women will find it easier to
qualify for a full state pension in the biggest retirement shake-up for
decades.
From next April, women born on or after April 6, 1950, will find that the age
at which they receive their state pension increases gradually — it will be
65 for all women by 2020.
At present, to qualify for a full state pension of £95.25 a week, women need
to have worked and paid national insurance contributions (NICs) for 39
years. Men currently need 44 qualifying years.
If you are caring for children under 16, or a sick or disabled person, you
qualify for home responsibilities protection (HRP). This cuts the number of
qualifying years required, but you still need to have worked for 20 years
and payed NICs to receive the full basic state pension.
From April 6 next year the qualifying period for a full pension will be cut to
30 years for both men and women. HRP will be replaced by a system of credits
for parents and carers, which will count towards your state pension
entitlement. A person will be able to build up entitlement to a basic state
pension on the carer’s credit alone.
