17 April 2015

4 important things to consider when deciding how to use your pension pot

There's been a vast amount of media coverage about the new pension rules since they were first announced just over a year ago, and picking out exactly what's changed, and what it means for you, can be tricky. Newspapers have claimed that greater freedom will result in lots of new opportunities for pensioners, from buying snazzy sports cars to investing in buy-to-let property. However, the changes can be more complicated than some headlines make them appear.

The new rules mean most people who have a defined contribution pension have a lot more choice about what to do with their money in retirement. The Government website, www.pensionwise.gov.uk will help to explain these choices. Before you start thinking through your pension plans talk to your existing provider about what your current pension offers. Then take time to explore your options to see if your current pension is still the best option for you.

At Nationwide we've been going through the new rules to analyse what they really mean – and what the implications are when you decide to do something different with your pension. Whether you're excited about the new possibilities, or just struggling to figure out what's going on, here are 4 important things to remember:

1. Not all pension providers offer every choice

It's easy to think that all pensions are changing, but that's not actually the case. The new rules are what's known as "permissive". In other words, pension providers now have the option of allowing you to do different things with your pot – but there's no rule that says they have to. This is important because some pension providers may choose to stick with their existing rules and systems rather than offering all of the choices that they can do under the new legislation. You may have to transfer your pension if you want to take advantage of the new rules – and that could involve paying exit fees, losing valuable product features or paying fees for the new pension.

2. You don't have to buy an annuity (but that doesn't mean you shouldn't)

The biggest change with the new rules is that you now have more options available on how to use your pension pot. You can use it to buy an income for life (called an annuity); or if your pension provider permits, you can leave it in the pension and withdraw money from it as and when you need to (called drawdown), or you can choose to take all or part of the fund as a lump sum. You can also combine these options in several different ways.

In the past, the ability to take lump sums or flexible drawdown payments was limited, so that it was only really an option for people who had quite a large pension pot to work with. Now there's no requirement to buy an annuity at all if you don't want to, and everyone has the choice to tailor their retirement income to their particular needs.

3. It's important to bear all of the tax implications in mind

The choices you make about when and how much to draw from your pension could have very different implications for how much tax you pay.

While you can usually draw 25% of your total pension pot tax free, anything over this is taxable as income in the tax year you take it. So if you're planning to take a lump sum or to drawdown more than 25% of your original pension pot to provide you with a retirement income (for example you may be thinking about becoming a buy-to-let landlord or investing in income-generating funds), it's important to talk to a tax specialist or an independent financial advisor about the tax implications of taking withdrawals.

Different tax rules also apply to money that's left in your pension when you pass away, and it's important to bear this in mind when you are planning for inheritance.

4. Getting your choices right first time can make a big difference

Because the first choices you make are so important, it makes sense to work out what your short and long term priorities are before you finalise your retirement plans. For example, if you choose to draw a large lump sum at the start of your retirement, you might well find restrictions on putting money back into your pension again. Likewise any funds you use for drawdown to put off a decision about taking an annuity may decrease the value of your pension pot and mean you could end up with fewer choices in the future.

What does it all mean?

It's important to take time to plan your finances in retirement carefully and make sure that you have enough money to support yourself throughout the whole of your retirement. The state pension isn't usually enough to give you a minimum acceptable standard of living in retirement, you can check how much state pension you will actually receive by using the state pension calculator on the Government website.

The further in advance you're able to plan, the better idea you'll have of how best to balance annuities, drawdowns and the tax-free lump sum that you have the option of taking. It's certainly worth taking time over your decisions, as they will have a big influence over the type of retirement that you enjoy.

Nationwide does not currently offer pensions but we could help you assess your retirement needs as part of our financial planning service.

You can talk through your finances with us to help you check your financial plans are on track to achieve your financial goals. Our Financial Planning Managers offer advice on a limited range of carefully selected products available through Legal & General. To benefit from this service you'll need a household income or savings of £50,000. Find out more about our financial planning service.

Tax information is based on our understanding of the current tax legislation and HM Revenue & Customs practice, both of which may change.

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