Financial
firms received around four times their normal volumes of calls last
week as the over-55s rushed to take advantage of the new pension
freedoms to pay off debts and fund one-off purchases of a lifetime. A
speedboat, a Bentley, a holiday home in France and a child’s wedding
were among the purchases over-55s have asked to withdraw money to fund since the rules came into force last Monday.
But among the callers were thousands who simply wanted to know how
they could get their hands on their cash. Some providers were reportedly
struggling to answer these queries, with call waiting times of up to
two hours. So here are the answers:
Where do I start?
There are essentially two ways of getting your money (aside from
buying an annuity). The first is the catchily titled Uncrystallised
Funds Pension Lump Sum route, more commonly known as UFPLS (usually
pronounced Ufplus), and the second is drawdown. However you take money
out of your pension, the first 25% of any withdrawal is tax free and the
remainder is taxed at your marginal tax rate – the highest rate you pay
on your income now (so 20%, 40% or 45%). Use your existing pension pot like a bank account (Ufplus)
With Ufplus your funds stay invested in your pension and you can draw
out money directly from this pot as and when you want. This has been
described as being similar to a bank account, but don’t be deceived –
withdrawal is not that simple and you will be subject to a tax payment
each time you do it.
This option is better suited to those who want to make smaller,
regular withdrawals over time rather than taking 25% of their entire pot
in one go. For each withdrawal 25% is tax free and the rest is taxed at
your marginal rate. One thing to bear in mind is that once you start
withdrawing using Ufplus, the amount you are allowed to pay into your
pension each year drops from £40,000 to £10,000.
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“Using
Ufplus to withdraw money is the best option for those paying £10,000 or
less into their pension each year and paying basic rate tax,” says
Chris Noon, a partner at actuary firm Hymans Robertson. “It has fee advantages – these will be lower than on drawdown – as well as tax benefits.” Take a big amount and leave the rest invested (drawdown)
Flexi-access drawdown requires you to move all of your retirement
fund from your pension pot into a drawdown arrangement, either with your
own provider or another provider (see “Who offers what” below).
This is a new version of what was previously known as flexible
drawdown. You previously had to have other pension income of at least
£12,000 a year to qualify, which is why it tended to be used only by the
wealthy. This rule was abolished last week.
Under flexi-access drawdown you can take 25% of your entire pot
tax-free in one lump sum upfront and leave the rest invested. You can
then take a regular income from the invested money if you want, which
will be taxed at your PAYE rate, or you can leave the lot invested until
a later date. And, unlike with Ufplus, you can continue to pay up to
£40,000 into your pension each year.
“I think you need to take advice before entering drawdown,” says Jamie Smith-Thompson, managing director of advisers Portal Financial.
“If you withdraw too much the fund is unsustainable. You have to look
at your expected mortality rate as well as where the underlying fund is
going to be invested.”
Not all pension providers offer drawdown and you may have to transfer
your pot to another firm. The annual fee in a drawdown fund also
varies.
As a guide, Noon says you should be looking for a total annual charge
of less than 1%. You also need to find out whether your existing
provider would charge you to transfer to another firm. “So if the charge
is, say, 1.1% with the drawdown provider you are looking at, and there
are buy/sell charges to transfer from your existing provider you might
be better off staying, if you can,” Noon says.
Wendy Peterman welcomes the pension freedoms and will buy an investment property. Photograph: A P Sturrock for the Observer
So is drawdown right for you? “Flexi-access drawdown is best suited
to someone who is a higher rate taxpayer. The charges are high compared
to Ufplus,” Noon says. “However, if providers don’t offer Ufplus the
danger is that most people will just stay with that provider and use
flexi-drawdown, even if that’s not their best option.”
Wendy Peterman, 55, is one of those who is taking money out of their
pension pot in the coming weeks – in her case to buy an investment
property. She is taking the 25% tax-free lump sum and leaving the rest
in a drawdown fund. She took advice from Devonshire Wealth Management before making the decision.
“Because I run an estate agency I am aware of the benefits of
investing in the property market,” she said. “The pension freedoms have
provided myself and my husband with access to the money to do it. We see
property investment as a way of earning more money than leaving it all
in our pensions.”
Withdraw your entire pension pot
You are also entitled to take the lot out. Most of the calls pension
providers received last week were from people with small pots who had
already made their mind up to cash it all in. However, there are tax
implications (see below).
Can I mix and match?
Yes – and this could be the best option for the majority. You might
decide initially to cash in the whole of a small pension pot from an old
policy that you no longer pay into, for example. Then you might take
some smaller sums from a pension pot you are still contributing to for a
few years. Further down the line you may then decide to go into
drawdown and/or buy an annuity with your remaining money.
“I don’t see the reforms as the death of annuities,” says Martin
Cawley of Devonshire Wealth Management. “There will be a cycle when they
are attractive again. Maybe not in the next 10 years, but they will
change and improve.”
What will I pay in tax?
There is a lot of confusion over the tax liability that comes with
withdrawing pension money. Research from Which? shows that six in 10
people aged over 55 who are not retired do not know that the pension
reforms allow you to take up to a quarter of your pot tax-free. One in
seven wrongly think their entire pot is tax-free.
You need to remember that the remaining sum, after the tax-free
element, will count towards your annual income for tax purposes. So you
might be a basic rate tax payer, but a big pension withdrawal could push
you into the higher rate tax band and mean you lose 40% or even 45% of
your money to the tax man.
That is one reason a lot of people will be better off withdrawing
money using Ufplus, as that way they make smaller withdrawals over time,
minimising their tax liability.
However, either way you may well suffer a whacking great tax bill the
first time you withdraw money from your pension. This is because HMRC
will apply an emergency “month 1” tax code meaning you could pay more
than 30% tax on your first withdrawal. You can avoid this by giving your
pension company a P45 for the tax year, or you can claim it back or
wait for it to be refunded at the end of the tax year.
You also need to consider the tax implications of what you invest in.
“Any interest you earn will be taxed outside of your pension,” says
Laith Khalaf of Hargreaves Lansdown. “You could put the money in an Isa, but then you are using up your Isa allowance for the same tax advantage as a pension.”
Which? has launched a free calculator on its website to help people work out the tax they will pay if they cash in their entire pot or just take a lump sum.
Will I have to pay fees?
Most providers won’t charge you to withdraw your money, but there are
exceptions. Royal London, for example, will charge a one-off £184 to
withdraw under flexi-access drawdown, while those with Axa’s Retirement
Wealth Account pension, a standalone Sipp, will pay £150 per transaction
to withdraw their money via Ufplus or drawdown.
Who offers what?
Not all pension providers are going to offer Ufplus – though most
will – and not all will offer drawdown. Virgin, for example, will only
allow someone to withdraw their whole fund and will not offer Ufplus or
drawdown. Others, including Zurich, will offer drawdown, but only for
customers who have taken financial advice.
Some firms will allow you to withdraw your money online without ever
speaking to an adviser. Standard Life, for example, will allow this for
pots of up to £50,000, whereas Scottish Widows only allows it on pots of
up to £30,000. Fidelity will not allow online access at all.
You can transfer providers if yours does not offer the access you want.
HOW UFPLUS WORKS
George has a £100,000 pension pot; he is 57 and earns £30,000 a year.
He wants to withdraw a one-off lump sum to buy a new kitchen. He uses
the Ufplus rules to withdraw £10,000. The remaining £90,000 of the pot
remains untouched and continues to grow free from further tax.
Of the withdrawal, £2,500 is tax-free and the balance of £7,500 is
taxed as income. He receives a net payment of £8,500. The remaining
£90,000 is still invested in his pension.
So how does flexi-access drawdown work? Here’s an example. Steve is
66 and has £100,000 in a self-invested pension plan. He uses £50,000 to
buy himself an enhanced annuity paying £3,200 a year. He invests the
balance of £50,000 in his drawdown, and takes the tax-free lump of
£12,500 and a monthly income of £100.
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