Pensions have always beenÂ complicated, but these days there is much moreÂ information to get your head around. Because of the radical changes in 2015, much of what youÂ have previously assumed may turn out not to be true after all. How many of these pension misunderstandings have you made?
âI used to be âwith itâ,â complained Homerâs elderly father in The Simpsons. âAnd then they changed what âitâ was.â
Someone else who feels like that is Bob. As Bob nears retirement, heâs forced to admit he doesnât understand as much about pensions as he thought. Having saved into a pension all his working life, he feels he ought to know how they work. But now the time is approaching when heâll have to start living off those savings, heâs feeling on shaky ground. Bob was never an expert to begin with, but so much has changed lately that heâs no longer sure where he stands. For exampleâ¦
What he thought: âPensions now work like bank accounts.â
What heâll discover: Bob has heard that pension freedom gives full access to his savings. âLike a bank accountâ is the phrase that he keeps reading everywhere. But thatâs misleading. Unlike money in a bank account, most of the money withdrawn from a pension counts as taxable income for that year. So drawing on his pension too freely could cost him dearly.
What he thought: âEvery year I can withdraw 25 per cent tax free.â
What heâll discover: This is another common misunderstanding. Itâs true that 25 per cent of every pension pot can be withdrawn tax free, with income tax payable on the rest. But that doesnât mean you can take out a quarter of it this year tax free, and then do the same next year with the remainder, and so on. Once youâve taken that 25 per cent tax-free lump sum, thatâs it. (Although another way to do it is with a series of smaller withdrawals, with 25 per cent of each withdrawal being tax free.)
What he thought: âI can access my pension when I reach retirement age.â
What heâll discover: For a long time Bob assumed he could draw his pension only when he reached state pensionable age. Only recently has he discovered that under the new rules, people can access their moneyÂ muchÂ earlier. This means that Bob, who has a few years to go until he can receive his state pension, could start to supplement his income from his pension pot, and so maybe enjoy a phased retirement. (Meanwhile, state pension age is gradually rising – check yours here).
What he thought: âPension freedom covers all types of pension.â
What heâll discover: As well as his main pension, Bob also has a small final salary pension from a previous employment. He thought heâd be able to access this money as a lump sum too. Instead heâs told he would have to transfer it into another scheme â but canât do so unless he takes independent financial advice. Bob should listen carefully to his adviser, who may well say that even a small final salary scheme is worth hanging onto.
What he thought: âWhen I die, my pension dies with me.â
What heâll discover: Bob already knew a bit about annuities (products that pay a guaranteed income until death) and was aware that some annuities will continue paying income to a surviving spouse after the original holderâs death. But he didnât know that pension freedom means that any unused pension pot or drawdown fund can be passed on to beneficiaries. Whatâs more, this is free of inheritance tax.
By not fully grasping how his pension works, Bob is potentially missing out on opportunities to improve his lifestyle in retirement â and could also be at risk of making serious mistakes or even falling victim to fraud. Fortunately, he visits unbiased.co.uk to search for a financial adviser â and so puts his retirement plans back on firm foundations.