Pension Release, sometimes know as Pensions Unlocking, is the term used when people want to release funds from a pension early. It applies to both Occupational Pension Schemes (whether they are Defined Contribution or Defined Benefit) and Personal Pensions. There is an age restriction that applies, which means you must be aged 50 or over. In 2010 this minimum age is increasing to 55.
Occupational pensions work in a different way from personal pensions. Nearly all personal pensions these days allow you to release funds from age 50, even if the plans were set up to an older age originally. However; it is also usually the case that if you decide to release a tax free cash sum (currently know as Pension Commencement Lump Sum – PCLS), then you will also be forced to buy an annuity with the balance.
The maximum PCLS is 25% of the fund value; the remaining 75% is handed back to the Insurance Company in exchange for them providing you with an income for the rest of your life. Whilst the cash sum is tax free the income is classed as earned income and therefore liable for income tax at your highest rate. This means that if you are a higher rate tax payer you will pay higher rate tax on the annuity; if you are a basic rate tax payer then you only pay basic rate tax. You must be careful though; when you add the income from the annuity to your other income it could push that part of your earnings into the higher rate tax bracket.
You do not have to buy the annuity with the insurance company the pension was taken out with. You can release the PCLS from them but buy the annuity with another provider. This is known as taking advantage of the Open Market Option (OMO) and all pension providers must offer you this option. It is important you take advantage of this because you can sometimes increase the income you receive substantially.
You also have a choice of what “shape” annuity you buy and this will depend on your circumstances at the time. For example, if you are married you may decide to include a pension that will be paid to your spouse in the event of your death – this is usually 50% of the pension you were receiving but does not necessarily have to be that amount, it can be 100%. You can also choose whether the pension is paid yearly or monthly or if it remains level throughout or increase by say 3% each year. However; you must remember that each extra benefit you add onto the annuity the smaller the payment you will receive in the first place. So someone with a £10,000 fund to buy an annuity, if everything else is identical, the annuity that includes a 50% spouses pension will be a lower annual payment than the annuity that doesn’t include a spouse pension. Or, the person who wants to include a spouse’s pension equal to 100% of their annuity would start with a lower annuity than the person who only includes a 50% spouse’s pension.
It is very important not to necessarily take the options being offered by your existing pension provider because there are always other choices. For example, you could decide to transfer your pension fund away from the existing contract you are in and put it into something that is more flexible.
You now have an option whereby you can still release the maximum PCLS (or a smaller amount if that is all you need) but decide to leave the rest of the pension fund invested in the plan to take some other time. This is not something you are likely to be offered with the existing plan. This is because it is a relatively new development in pension legislation and was only introduced in April 2006 – so if your pension was taken out before this date (and quite possibly even after this date) the contract is not likely to have been amended to allow this option so the only way you can take advantage of it is to transfer into a new contract that does have this facility.
You must be careful with this because there are sometimes penalty charges applied when personal pensions are taken earlier than originally intended. Also, there are sometimes guaranteed rates that only apply if a pension is taken at the original selected retirement age, so if you elect to release your pension early you could loose out. Mind you, sometimes when a pension provider makes a penalty charge for accessing the plan early, all they are really doing is clawing back the charges they would have made had you left the pension invested to your original selected retirement age. In other words, they are going to take these charges anyway it’s just a case that if you release your pension early they take it in one go rather than a smaller annual amount being deducted form the funds if you left them.
Whatever the reason you are thinking about releasing your personal pension early for, it is extremely important you don’t make a rash decision. Even if there aren’t any charges or penalties for releasing a pension fund early, you are still likely to get less than you would have got had you waited until your normal selected retirement age. So make sure you spend some time investigating all your options before making a final decision.
Think about whether you will have enough income in retirement and if the reason you want to release money from your pension early is a good enough reason, or if there is an alternative way of achieving what you need other than releasing your pension early.
If you are looking at releasing money from an occupational pension earlier than normal there are other issues you need to consider. Defined Contribution (DC) pensions are not usually as good as a Defined Benefit (DB) pension.
With a DC scheme you usually pay in a percentage of your salary and your employer also contributes. The pension you eventually get in retirement will largely depend on the size of your pension fund. A DB scheme works differently. With these sorts of schemes you get the promise of a pension paid in retirement, which is dependant on how many years you work for that employer and what your final salary is. The longer you work for that employer the bigger the percentage of your salary you will get as a pension in retirement.
What makes DB schemes so good is that you, the member, has no investment risk at all, it is all down to the employer taking the risk. This is because you are promised a pension at retirement based on a percentage of your final salary. Whatever the cost it is for the employer to pay you that pension, they must find the money. If there is a stock market crash or some other event that means the value of the pension fund reduces, it is not your problem. You will receive the pension you are promised at retirement and your former employer must pay it.
With both DB and DC schemes you should never even consider releasing funds early if you are still an active member of the scheme. This is because you will lose the contribution being paid in by your employer, and quite likely lose other ancillary benefits such as life assurance, known as Death in Service.
Defined Contribution schemes will operate on a similar basis to a personal pension when considering the merits of pension release. Defined Benefit schemes are completely different and you are likely to reduce pension benefits considerably if you release your pension early. In fact, these types of scheme are universally considered to be the best types of pension scheme you can have so you should only consider releasing benefits early as a matter of last resort.
When thinking about Pensions Unlocking you should always seek professional advice and look at all your options before making a final decision as to whether it will be suitable for you.
