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How will the new pensions system work?

Pensions are being radically transformed under plans announced in the Budget yesterday.

From April 2015, savers will be given total freedom over how they withdraw pension money. In the meantime, temporary measures will be put in place to ease the strain on those seeking a retirement income.

Here we explain how the changes affect savers.

How do pensions work today?

Savers who put money into defined contribution (as opposed to workplace final salary schemes) currently have three options to access the money after age 55.

If they have less than £18,000 in total pension savings, the entire lump sum can be taken as cash (this is called “trivial commutation”). Of this, 25pc is tax-free; the remainder attracts income tax at the individual’s marginal rate.

Savers who have more than £18,000 in cash can take up to two pensions worth up to £2,000 as cash lump sums, again subject to income tax.

The second option, used by the vast majority of pensioners, is to buy an annuity. This is a form of insurance that provides a guaranteed monthly income that lasts until death. A 65-year-old with a £100,000 pension can obtain just £5,800 a year from an annuity today, unless he or she suffers from medical conditions which enhance the payout.

The final option is to leave the pension invested in the stock market and take a gradual income. This is called “income drawdown”. Unless a pensioner can show £20,000 of guaranteed pension income from other sources (for example, the state pension, final salary pensions or another annuity), their annual income is capped.

Currently the maximum a 65-year-old with a £100,000 pension can withdraw is £7,080. Anything withdrawn above this amount is classed as an “unauthorised payment” by HM Revenue & Customs and attracts a 55pc tax charge. As a result, no major pension provider offers this facility.

Individuals with £20,000 of income from other pension sources can make unlimited withdrawals, subject to income tax at the marginal rates. This is called “flexible drawdown”.

Source The Telegraph

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