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Pension Freedoms Explained: What Are My Choices?

Last updated 23rd November 2021

5 min read

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The Pension Freedoms legislation was introduced in April 2015, giving individuals more freedom towards how they choose to access their pension pot.

Before the pensions freedoms act came into effect, individuals had restricted access to their pension. A 25% tax-free cash lump sum could be withdrawn, however the remaining funds had to be provided as a regular payment for life. Fortunately, there is now much more freedom when receiving your pension.

To help you understand the different choices available to you, this guide will discuss which pensions are covered under the legislation, what your choices are and the necessary tax implications to consider.

As always, the decision you make is completely up to you, however we hope this guide helps you to feel more confident when it comes to managing your pension.

Are all pensions covered under the Pension Freedoms act?

No, only defined contribution pensions are covered (also known as ‘Money Purchase’ pension schemes).

You may have a defined benefit pension, which is not covered under the Pension Freedoms legislation. Also known as a final salary or career average pension, these schemes usually pay a secure income for life based on your salary and length of service with your employer.

Due to the set up of defined benefit pensions, you will not have the same accessibility choices as you would with a defined contribution pension.

Can I transfer to a defined contribution pension?

If you currently hold a defined benefit pension but would like access to the same freedoms outlined in The Pensions Freedom legislation, it is possible to transfer your funds into a defined contribution pension.

It is essential that you seek independent advice before you make this decision, as you will be sacrificing a guaranteed regular income which increases each year. Of course, the decision is yours to make in light of your circumstances.

Pension freedoms explained

From the age of 55, you will be able to make a decision on how you receive your pension. From leaving your pot completely untouched to drawing some, or all, of your funds out at various different times, the choice is yours.

We've listed your 6 options below when it comes to accessing your pension pot, though we can’t make the decision for you. Use our guide to learn about your options and if you’re still unsure, seek independent financial advice.

1. Leave your pot untouched

Ultimately, it is up to you whether you withdraw funds in your pension pot or not. It is completely fine to leave your pension untouched until you need it later in life.

2. Guaranteed income or annuity

With guaranteed income, you are able to use your pension pot to buy an annuity. This means you will be provided with a guaranteed income for the rest of your life, though the type of annuity can differ depending on which company you choose.

When you buy your annuity, many factors are taken into consideration, including age, your lifestyle and the type of insurance you have chosen. This will impact the amount of guaranteed income you receive.

You don’t need to use all of your pension to purchase a guaranteed income. If you wish, you can also take out up to 25% of your pension as a tax-free lump sum.

3. Adjustable income or drawdown

With an adjustable income, or flexi-access drawdown, you’re able withdraw a 25% tax-free lump sum while keeping the remaining 75% invested to give you a taxable income.

In this instance, you have control over how much you take out and when - though the amount available to you will depend on how well your investments perform in the stock market.

Be aware that some providers may charge a fee for choosing and managing investments.

4. Take cash in chunks

Otherwise known as an ‘Uncrystallised Funds Pension Lump Sum’, you’re able to take cash out of your pension pot in chunks until it runs out. There are usually no limitations as to how much you can take each time or how many times you withdraw.

Each time you withdraw a cash lump sum, 25% is tax-free and 75% is taxed.

5. Withdraw entire pension pot

If you wish, you are able to withdraw the entire value of your pension pot in one lump sum.

It will be essential to consider the tax implications of this choice as any earnings above the personal allowance for the current tax year will be subject to income tax.

Again, 25% of your total pension pot will be tax-free, with the remaining 75% taxable.

6. Mix your options

Throughout life, there are many unexpected surprises and your priorities are likely to change over time. This is no different after you reach the age of retirement.

The pension choice you make at 55 may not be the best option for you in the future. Fortunately, you’re able to mix your options and change how you receive your pension throughout your retirement.

Say, for example, you chose to take cash out in chunks at the start of your retirement. There is nothing stopping you from changing to an annuity later on in life to receive a guaranteed income.

If you have more than one pension, you’ll be able to choose different options for each one. This gives you complete flexibility with how you receive your pension.

Tax implications for pension withdrawals

Usually, you are able to receive up to 25% of your pension pot tax-free. The remaining 75% of your pension is taxable as earnings.

Your personal allowance will remain the same as before retirement (find out current tax rates here), meaning any income above the current yearly rate will be taxed. If you do not receive earnings above the personal allowance, your pension will not be taxed.

With this in mind, you will need to consider the tax implications when taking out a cash lump sum. The more you take out, the more likely you are to pay additional tax rates.

You can read more in detail about tax on pensions in our helpful guide.

Further guidance on pensions

In order to help individuals aged 50 and over with their choices when it comes to pensions, the government has set up Pension Wise - a national service offering free, impartial guidance. Pension Wise can be contacted via telephone or in person, with easily bookable appointments on their website.

If you’d like to do some more reading around pensions and managing your money over 50, we also have a number of guides which you may find useful: