Are you ready for the pension revolution?

The current rules

At present, if you are aged 55 or over, you can take 25% of your pension savings as a one-off, tax-free lump sum. Most people then use the rest of their pension pot to buy an annuity — that is, they cash in their pension pot with an insurance company, which pays them an income for the rest of their life.

From April 6, though, once you reach 55, you will be able to withdraw money from your pension in any way you wish. So, for example, if you want to take out your whole pension fund, 25% will still be tax-free, and the rest will be taxed at your highest rate of income tax.

Alternatively, you might want to take out a series of smaller lump sums, in which case, 25% of each withdrawal you make will typically be tax-free and the remainder will be taxed as income.

If you want a regular income, you can take 25% tax-free and use the rest to buy an annuity, or you can use what will be known as “flexi-access drawdown”, where you keep your pension invested in retirement and “draw” an income from it.

Remember, not all pension providers will provide the full range of options next month, so check what yours plans to offer.

At the moment, you can use only flexible drawdown — which means you can take out, or draw, as much from your pension as you want — if you have a guaranteed income from your pensions of at least £12,000 a year, including the state pension. The maximum state pension is worth £113.10 a week, so about £5,880 a year.

From April 6, you will be able to move to flexi-access drawdown without having to prove a set guaranteed income. Remember, if you draw too much from your pension, there is a risk you could run out of money in later years, so think carefully before acting.

Kate Smith, the regulatory strategy manager at the pension provider Aegon, said: “The overriding message is that while new pension flexibilities give you far more options, it’s important to plan how you are going to spread your income across retirement, because there’s likely to be a range of factors to consider.

“A lump sum will be right for some but its benefits need to be considered in the context of how much tax you’ll pay and from where your regular income will come.”

Final salary pensions

Those with final salary pensions, also known as defined benefit schemes, will have to transfer to a defined contribution scheme to take advantage of these new freedoms.

However, in many cases this will involve giving up valuable guaranteed benefits, so it is vital to seek independent financial advice first.

Tom McPhail at the adviser Hargreaves Lansdown, said: “Inevitably, some defined benefit scheme members will be seduced by the short-term appeal of ready cash in preference to the longer term and less tangible benefit of a guaranteed lifetime income. For some, this may be a logical or life planning decision. However, it is also a decision that some may come to regret later in their retirement if the cash runs out.”

Restrictions on contributions

Currently, you can contribute up to £40,000 a year into your pension. This amount includes any contributions from your employer. If, after April 6, you take money from your pension in addition to the tax-free cash, you will be allowed to pay in and get tax relief on only up to £10,000 a year.

In addition, you will not be able to carry forward unused contributions from the previous three tax years. If you pay in more than the annual allowance, you will be hit with a 55% tax charge on the amount by which you have exceeded it.

This is to stop people taking money from their pensions and then paying it back in to get extra tax relief.

If you are already in a capped drawdown scheme, which restricts the amount you can take out each year, or if you set one up and withdraw cash before the April deadline, then you can hang on to the £40,000 pension contribution limit.

Tax cut on inherited pensions

Under current rules, you must pay a 55% death tax charge on a pension left to you by someone if they have taken any tax-free cash or income from it.

Pensions sit outside your estate — they are not included in the £325,000 tax-free amount that can be passed on before inheritance tax is charged.

From April 6, this 55% tax charge will be scrapped. If someone dies under the age of 75 and leaves you their pension, you can take money from the pot without paying any tax, even if it has already been tapped into.

You can take the whole fund as a tax-free lump sum, or you can draw an income from it, either using an annuity or income drawdown.

If someone dies aged 75 or over and leaves you their pension, you will pay tax only at your marginal rate — that is, the highest rate at which you pay income tax — as you draw money from it.

If you want to take the whole fund as a lump sum, it will be subject to 45% tax. This will be reduced to your marginal rate of income tax from 2016-17 onwards.

Access to guidance

All savers will be offered, but do not have to take, free guidance when they access their pensions, as part of a new government service called Pension Wise (pensionwise.gov.uk).

The service is being offered by the Citizens Advice Bureau (CAB) and The Pensions Advisory Service (TPAS). You will be entitled to one free 45-minute session.

CAB has so far released the names of 44 bureaux across England and Wales that will offer face-to-face guidance, while TPAS will provide telephone guidance.

However, if you want advice tailored to your individual circumstances, or specific recommendations, speak to an independent financial adviser (IFA).

A good adviser should help you make informed decisions about your financial future and map out a plan to achieve your goals.

Make sense of the jargon

Here is our run-down of some of the pension terms you are likely to come across — and what they mean.

Annuity
If you give your pension pot to an insurer when you retire, you will receive an annuity, or monthly income, for the rest of your life.

Some annuities will also pay an income to your spouse if you die first. They are known as “joint life” annuities. An annuity that simply dies with you is known as a “single-life” annuity.

Drawdown
Keeping a pension invested in retirement, and drawing an income directly from it.

Tax-free lump sum
You can usually take up to 25% out of your pension tax-free once you reach the age of 55.

Sipp
A self-invested personal pension is a type of pension that has the same rules as other personal pensions, but gives you greater control over how your retirement savings are managed, as well as access to a wider choice of investments.

Basically, you can manage the money yourself by choosing which shares or funds to buy, or even investing in commercial property.

Defined contribution pension
A pension scheme into which you, and usually your employer, pay in money.

The amount you receive at retirement is the total pot of contributions plus any investment growth.

Defined benefit pension
This type of company pension promises to pay out an amount based on how much you earn at the time you retire (final salary scheme), or an average of earnings from throughout your employment (career average scheme).

Useful contacts
The Pensions Advisory Service (TPAS). Website: pensionsadvisoryservice. org.uk
Phone: 0300 123 1047

Money Advice Service (MAS).Website: moneyadviceservice.org.uk
Phone: 0300 500 5000

You can find a regulated, local independent financial adviser through the website Unbiased.co.uk or Vouchedfor.co.uk.