What are the pension changes?

From April 2015, a number of significant changes took place in the way that people can use their pension funds.

A raft of restrictions were swept away and replaced with a new freedom to draw out variable amounts or, indeed, completely exhaust a fund if desired. However, it is crucial to note that 75% of a withdrawal is treated as taxable income. Also the reforms don't apply to pensions in payment or salary linked pensions.

The previous regulations allowed very limited options to those that had built up pension funds through their working life. Because tax relief is provided on contributions, the thinking of governments until now, was that the accumulated funds should only be used in a way that minimised the risk that funds would be exhausted in the lifetime of the pensioner. So this meant buying a guaranteed annuity or drawing a restricted amount from an invested fund.

As explained in our article on annuities, these have become unpopular due to the prevailing low interest rates and increasing longevity assumptions from insurance companies. Drawing down from invested funds had been generally considered an option for wealthier retirees who could withstand losses due to large disposable income. So it was a huge change to introduce a framework that swept aside the concerns that not only could funds be exhausted but the less wealthy could draw down from a still invested fund.

So what are the risks and benefits of the new rules?

The biggest risk is that, for whatever reason, someone draws out the entire pension fund, paying a considerable amount of tax and invests the money poorly or spends it. In the category of investing poorly would be to draw all the money and leave it on deposit, as had the money been left in the fund the interest received would be tax free and there would have been no large tax bill on the total withdrawal.

The biggest benefit is that properly informed retirees can vary their income and investment strategy to suit changing circumstances. Doing this properly though, will require regular assessments and planning and the risk is that decisions are postponed and a drastic reduction in income is encountered.

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