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Changes to the rules for many pensions from 6 April 2015 mean more flexibility to draw money out of pension pots, but LITRG warns of tax issues that apply.

Background

Pensions are changing. From 6 April 2015, many of the rules limiting the amount you can take out of pensions and when are being swept aside. They are being replaced with ‘free choice’. This means that, from the age of 55, you will have much more control over what you take out of your pension, and when. However, LITRG draws attention to the fact that a hasty decision could cost you heavily in the form of an unwanted tax bill and even a tax credits/benefits overpayment.

The rules will still be complicated in many ways and you should try to understand them before you act. LITRG will be posting more information on its website in the near future, but it might help you to understand the following key points right away.

Pension flexibility comes in from 6 April 2015

• Your pension provider might allow you to take what you like, when you like, from your pension.
• The minimum pension age is 55 for most people.
• It applies to ‘defined contribution’ or ‘money purchase’ pensions – those where you have saved up a ‘pot’ of cash or investments and have to choose what you do with it.
• Rules about cashing in existing annuities do not come in until 6 April 2016.

‘Defined benefit’ or ‘final salary’ pensions will still have stricter rules

• These are a type of workplace pension and they provide benefits based on your salary from your employer and length of time as a member of the scheme. The amount is determined by the rules of your pension scheme.
• You may or may not be able to take out cash, depending on your pension provider, certain rules and limits.
• Decisions on these pensions need careful thought and advice before taking action.

There is no rush!

• Just because the new rules start in April 2015, you do not have to decide now.
• Consider everything – your circumstances (personal and financial), investment choices, future plans and, importantly, tax consequences.

Know the tax consequences of your decision

• You are allowed to take some money (usually 25%) out of your pension tax-free.
• But three-quarters (75%) of your pension savings are taxable as income.
• Taxable amounts will be added to your other income, probably giving you an extra tax bill.
• Plan ahead: you might pay less tax on money from pensions if you take it in stages, spread it out over a number of tax years, or wait until after you have stopped work.

Understand the tax ‘paper trail’

• Money from pensions will be taxed under the Pay As You Earn (PAYE) system.
• You might not pay the right tax at the right time.
• You might get PAYE ‘coding notices’ from HMRC or papers (such as a P45) from your pension provider.
• You might need to claim a tax refund or pay some more tax later.
• HMRC might send you a tax calculation or self-assessment tax return.

Watch out for tax credits consequences

• If you claim (or might otherwise be eligible to claim) tax credits, taking money out of a pension could cost you dearly.
• Taxable income from pensions is also income for the purposes of tax credits.
• You could end up with a tax credits ‘overpayment’ – this means that you may have been paid too much and have to pay it back. It could also mean you end up with less tax credits in the following year as well.
• You do not actually have to tell the Tax Credit Office about changes to your income until you renew your claim at the end of the tax year, but you might wish to tell them sooner about money taken from a pension in order to reduce the amount of any overpayment.

Check the effect on state benefits (including Universal Credit)

• A one-off or irregular sums taken from pensions could be treated as ‘capital’ for the purposes of means-tested state benefits.
• Regular amounts taken from pensions are likely to be treated as income.
• Either capital or income treatment could have an immediate effect on your entitlement to state benefits, depending on your overall circumstances.
• ‘Local’ benefits like Council Tax Support could also be affected.
• Check your situation carefully before taking money out of your pension.

Take further advice

• Use the Government’s ‘Pension Wise’ guidance service – either online, or by making a telephone or face-to-face appointment.
• Get specialist advice on your tax position – see the ‘getting help’ page on the LITRG website for more information.

The above is an outline only and is not intended as a detailed guide. Watch this space for further guidance – LITRG will let you know as soon as it is available.

Useful links

LITRG article with links