The chancellor George Osborne has just published his Taxation of Pensions Bill, which provides some further clarity on the pension changes which are being proposed.
One of the main changes is the rules around withdrawing a tax free lump sum, as they will become less strict from April 2015.
At present individuals are allowed to receive 25% of their pension pot at retirement, tax free. Although the amount of tax free lump sum is to remain at 25% with the changes, it is the rules around accessing the lump sum that are being relaxed.
Using an example of an individual who has a pension pot of £200,000 and is age 55 or older. Under the current rules, the individual could take out £50,000 (25%) right now as a tax free lump sum. Once this has been taken, the remaining £150,000 can be used to buy an income with the purchase of an annuity, or they could set up income drawdown pension, which will allow them to take an income (within limits) while the remainder of the pension pot continues to be invested.
The first set of rules announced in March, will create greater flexibility on the amount of income that an individual can withdraw from their pension, as they will no longer be restricted by limits.
Under the most recently announced rule changes, it will mean that individuals no longer have to take all of their tax free lump sum in one go. Instead they can take their tax free money in separate yearly tranches.
To see how this works, lets assume the individual hasn’t touched their pension pot before April 2015, but they want to withdraw £10,000. They will be able to do that by withdrawing the sum as a Uncrystalised Pension Fund Lump Sum (UPFLS). The individual would receive £2,500 tax free and they would have to pay income tax on the £7,500 at marginal rate.
This could mean that with careful planning, pensioners end up paying a lot less tax when they come to draw their pension.
In addition, if there is anything left in the pension pot when the individual dies (if they die before age 75), then this can pass tax free to beneficiaries. If the pension owner dies after 75 then withdrawals made by the beneficiary will be charged income tax at their marginal rate.