A bright new dawn

Retirement is supposed to be about enjoying the freedom to do whatever you want – but for many people this wasn’t reflected by the way in which they could access their pension.

If you are in a defined contribution scheme, there were restrictions over how you could utilise the pot of money that you have spent most of your life building up, once you came to need it in retirement. At least 75% of your pension had to be used to arrange a retirement income, which caused many people to go down the increasingly unpopular annuity route.

These significant changes offer greater flexibility and freedom in shaping your retirement.

But now the government has changed this, following a radical overhaul of the defined contribution pension rules (defined benefit scheme rules remain unchanged). As of this April, you can access your full pot of money from the age of 55, and use it however you like. This is a significant change that offers greater flexibility and freedom in shaping your retirement – but it also requires a major rethink in how you plan for this important chapter of your life.

The pitfalls of a rash decision

The temptation to withdraw your entire pension fund in one swoop has to be tempered by the important tax considerations. In line with the previous rules, only 25% of what you withdraw will be tax-free. The remaining 75% will be treated as your income and taxed at your highest marginal rate. This could significantly reduce the amount of pension savings you receive.

Equally, withdrawing your pension should not be treated as an opportunity to go on a spending spree. If you plan to rely on this pot of money to fund your later years, it clearly needs to last. There are fears that some people will squander their full pension pot and rely on the basic state pension as a fall back option; but the state pension is highly unlikely to be enough to support your desired lifestyle.

Keeping your pension invested

The government has also scrapped the minimum income requirement rules around keeping your pension fund invested via flexible drawdown, making this option accessible to everyone.

Previously, if you wanted to keep your pension invested in retirement, but didn’t have at least £20,000 guaranteed pension income sources (or from March 2014, £12,000) you had to choose the capped drawdown route rather than flexible drawdown. However, with capped drawdown, there are restrictions on how much income you can take each year. From 6 April 2015 flexi-access drawdown accounts will be available with no limits on the amount you can withdraw. With the minimum income requirement removed, it is now an option accessible for everyone.

The main advantage of keeping your pension fund invested via flexible drawdown is that it can continue to potentially rise in value. However, it also means that your fund remains subject to an element of risk and may fall in value. Making large withdrawals could also exhaust your pension’s value completely.

It is good practice for people approaching retirement to reduce the level of risk their pension is exposed to as they prepare to give up work – in fact, many pension schemes automatically do this on your behalf. Yet if you do plan to keep your pension fund invested during your retirement, you might not want to alter your risk and reward approach in this way.