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Many have welcomed the pensions reforms currently being introduced by George Osborne in the UK which give retirees freedom to access their pension pots from age 55 and invest, spend or save the cash as they wish. In his 2014 budget, George Osborne announced that retirees would have “complete freedom to draw down as much or as little of their pension pot as they want, anytime they want”. In the wake of the announcement of the new regulations, Pensions Minister Steve Webb famously joked that savers could even blow the lot on a Lamborghini if they so choose.
It seems that few are planning to be so reckless! If a poll conducted by Saga, an organisation focusing on the needs of the over 50s, is to be believed, the vast majority of people plan on using their newfound pension freedom wisely. Just 23 people out of 2,400 planned on blowing it on luxury items, the majority were seeking sensible ways of managing the money to guarantee themselves an income to fund a comfortable retirement. The Treasury estimates that a third of retirees will opt to extract taxable lump sums from their pension pots to pay off debts, spend or invest.
What many may not realise however, is that taking a large lump sum could bring them into the top tax rate for the first time in their lives. For example, an individual who takes a £100,000 pension pot as a lump sum to invest in a buy-to-let property which would give them an income to live off during retirement, could pay as much as £34,500 in tax.
The Chancellor has not been quite so outspoken about these tax implications but the Institute for Fiscal Studies has calculated that taxation on pension drawdowns could boost government income by up to £320mn in the current tax year and £1.2bn by 2018-19 (although in the long term it predicts a reduction in income for the government).
The right to choose how to use a pension can only be a good thing. Whereas previously most retirees found themselves forced into buying an annuity which might not have been the best option for them, now there is the luxury of choice. Choice does bring with however, a burden of responsibility as well as a need for restraint to ensure that savings are not depleted early on in retirement, especially as most 60-65 year olds under-estimate their lifespan.
Those approaching retirement and thinking of drawing down their pension should seek professional advice regarding the tax implications of withdrawing a large proportion of the pension pot. The government has used funds from a levy on financial firms by the Financial Conduct Authority to set up and the Money Advice Service, which will offer free and impartial advice. However, your personal financial adviser will be better placed to advise on your particular situation and help you get the best out of your retirement fund in the most tax efficient way possible.
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Disclaimer: Infinity is not licensed or qualified to give tax advice.
This article is intended for information only and does not constitute tax advice. If you are in any doubt about your tax status please contact a qualified professional.