From April 2015, the government is finally giving us absolute freedom to spend our pension pots as we wish. Currently, most people are effectively forced into buying an annuity, an income for life, when they retire. Given today's rock bottom annuity rates, the decision to give us unrestricted access to our own money has been widely celebrated. But watch out, freedom can also be dangerous.

The Good and the Bad of Pensions Freedom

BAD POINTS

There is bad news if you have already bought a lifetime annuity with your entire pension pot, as you will remain locked into that annuity for life.

GOOD POINTS

Don't be too upset, an annuity gives you a guaranteed, sustainable income that will continue for as long you live. That is still a valuable benefit.

If you have taken out an annuity that lasts for a fixed term, say, five or 10 years, you can take advantage of your newfound freedom when that expires.

If you plan to retire in the next few months, the good news is that you can defer your annuity decision until next April. You can still take 25% as a tax-free cash lump sum today, and the remainder under the new rules.

 

BE WARNED, ONLY 25% IS TAX FREE

After you have taken your tax-free lump sum, the remaining 75% is subject to income tax. If you take it all in one go, that could push you into a higher tax bracket, landing you with an expensive bill. It may therefore make more sense to draw cash from your pension over a number of years.

Pensioners with smaller pots may be free to take their entire retirement savings today. If one of your pensions is worth less than £10,000, or your combined pots total less than £30,000, you can take the money as a lump sum, under so-called "trivial commutation" rules. You must be over 60 to do this. Again, watch out for the tax charge.

 

April 2015

After next April, many people may want to leave their pension invested through a scheme known as income drawdown. This allows it to continue growing, but you can still draw income from your pension. This is a risky option, however, because your pot could shrink if stock markets fall. Given the dangers, many pensioners will renounce their newfound freedoms, and buy an annuity anyway. This is still the best way of guaranteeing that you won't run out of money in your final years.

If you do this, don't just buy the annuity offered by your insurer, but shop around for the best deal, a process known as 'taking the open market option'. Insurers are expected to launch new flexible products in the run-up to next April, giving you a wider choice of annuitites.

Whatever stage you are at, the most important thing is to make sure your pension savings last for as long as you do, so you don't run out of money in your final years. Otherwise freedom could prove expensive.

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