Can you really use your pension like a bank account?
Of the raft of pension changes announced this year, one of the most recent ones to grab headlines is the declaration that pensions can be used "as a bank account." This is an excellent sound bite for journalists, but it isn't entirely true and people will need to be careful.
Many people will interpret this to be literal, but that won't be the case. A bank account has certain qualities, typically the holder has a debit card to remove money at a cash point or to purchase items in shops and online banking allows the account owner to view transactions, transfer money and pay bills.
None of these will apply to pensions, even after the freedoms come into effect in April 2015. The choice of phrase was unlikely to be chosen to deliberately deceive the public - although that may be a consequence. Instead, it seems it was intended to draw attention to the change allowing people to remove "as much or as little as they want" from their fund.
Arguably, this does provide some of the accessibility of a bank account and that is a new development for pensions, but it's a broad statement that doesn't include the nuances and restrictions to be considered. For example, you can't go to a cash point when you turn 55 and take money out of your pension. To access the money, you will need to talk to your pension provider and request a certain amount to be removed, and you will almost certainly need to wait for it. The timeframe may change in line with the freedoms, but at the moment it can take between three and four months to withdraw money from a pension - hardly the same as taking money out of your bank account.
Unlike a bank account, there will be tax implications: the first 25% of every withdrawal will be tax free, but tax will be applied at the marginal rate on the remaining 75%. Immediately, then, there's the issue that if someone needs £500, they will need to withdraw more than that from the fund to take tax into consideration. A basic-rate taxpayer would be left with £425 after tax and a higher tax payer will be left with £350 (40% tax) on a £500 withdrawal. Depending on other earnings, and how much is taken from the pension fund, the withdrawal could even push the person into a higher tax bracket, and because the money can be taken without professional advice, it will be up to the pension holder to understand the risks and consequences.
Advice is another concern with this new measure. Current rules state that before opting for income drawdown - where you take an income directly from your fund throughout retirement - professional advice must be sought. The Budget also stated that there will be free guidance from next April for people approaching retirement. This makes it a peculiar decision to allow people to remove money from their pensions as and when they want to, and there's a lot of potential for people to mismanage the fund and face a large tax bill or deplete their fund too quickly. Caution is definitely needed, and we strongly recommend talking to a financial adviser before accessing the fund, even though it isn't a legal requirement.
Another aspect that differentiates pensions from bank accounts is that not all scheme providers may offer this new flexibility. This means there are likely to be a number of people looking to withdraw some money, only to discover that their provider won't let them. This could prompt people to transfer into a new scheme, which will involve fees.
It's worth remembering that the pension freedoms are not removing existing options, only providing a greater range of choices. So if you would rather access the 25% tax-free cash in one chunk, you can, just as you can still purchase an annuity or choose income drawdown.
Does the ability to remove money from your pension whenever you want appeal to you? Let us know in the comments below.
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The details provided in this article are for general information only and are in no way deemed to be financial advice. All of the material is correct as of the publication date, but could be out-of-date by the time you read the article. For our latest information and news, please see our articles section: https://www.portafina.co.uk/whats-new\
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