Cry Freedom – Guide to Pension Freedoms
Oh to be free. Well financially free at least. If you have a UK pension you can now “free your pension” by taking all the money out of it in one go.
Pension Freedom rules.
By now many of us will be familiar with the quote from the pensions minister, Steve Webb, about buying a Lamborghini. However, to take money from your pension you have to be age 55 or older. Your pension also needs to be a defined contribution (money purchase) type of pension. Final Salary pensions cannot be “freed” without taking an intermediary step of moving to a defined contribution pension first. Extreme care is needed if you are thinking about moving from a final salary scheme. Usually you will need the assistance of a specialist pension adviser. State pensions are also not included in the rules for pension freedom.
This is new legislation that came as a bit of a surprise. Consequently, some of the systems put in place to allow the withdrawal of cash from your pension are a little shaky. Here are some of the things we have identified as system problems:
The law of the UK says you can withdraw cash but your contract was started before this became law. Withdrawals require state laws and the specific contract to both allow this facility. Not all pensions will allow cash withdrawals
There may be surrender penalties still applied to your withdrawal. You need to check this in advance as part of your assessment on whether to take cash from your pension or not.
It will not happen quickly; a process time of 3 to 6 months is quite likely. Wait till you have cash in hand before booking that cruise or buying the Lamborghini.
UK Tax will be taken from your withdrawal. Also, and a BIG practical issue, is that HMRC are calculating tax only on the basis of a P45 (the form you receive when you leave a job). If you cannot supply a P45 for the current tax year, the pension company has to apply an emergency tax code. Any amount withdrawn over 25% of the value of your pension will be added to your income. In the majority of cases this will result in overpayment of UK tax. We have been promised that we can reclaim any overpayment, but again this is cash you will not get in your hand until later.
Living in Spain – Tax
As a person living in Spain we all rely on the fact that there is a Double Taxation Agreement (DTA) between Spain and the UK. However, in the case of pension freedom monies this may not apply. The reason is that money from this pension source, even though it is a lump sum, will be taxed as income tax in the UK. In Spain, these monies will be taxed as Savings Tax (Gains Tax). As they are two different types of tax, the double taxation agreement can conceivably not apply. I am writing this article three days after the introduction of the new law in the UK and as yet the Spanish Agencia Tributaria (Hacienda) have not yet confirmed if it will be part of the DTA. If not, you could be taxed 45% in the UK and a further 24% in Spain. If you live in Spain, wait for confirmation that there will be no double taxation before taking your UK pension as cash.
How to use your pension – take it or leave it
There is no one answer that applies to everyone. You now need to consider your own circumstances and make a decision based upon what is correct for you. However, here is a checklist of some of the things that will affect your decision on whether or not to withdraw your pension cash. All of these matters you should consider before taking your pension.
- What type of pension do I have?
- Does it have any special benefits – in particular does it have a Guaranteed Annuity with a very high rate of return?
- Do I have other investments? If so, make a comparison of the effect of a cash withdrawal between the different investments?
- What will be the tax I will have to pay?
- Do I have other sources of reliable income. The less alternative sources of reliable income, the more wary you should be of taking cash from your pension?
- What happens to my spouse’s income after I die?
- Am I likely to pay Inheritance Tax (remember question applies to both Spain and UK) ?
- How long will I live?
- What things am I worried about in the future? Medical care, cost of care etc.
Why does this matter
Taking cash from your pension now and spending it will affect your future income. So having an idea of how long you will need an income for is very useful.
Real Freedom comes from being able to choose
The ability to spend cash is different from having financial freedom. Not locking all your money into one type of investment, be that property, pensions or stamp collections, is the starting point. Having a diversified set of investments gives you flexibility and what comes from that flexibility is the ability to choose. Shall I spend some capital now, can I take a bit more income, can I afford to help the family and can I pay for care? Make sure you can choose.