The pensions genie is out of the bottle

Many of the headlines following March's Budget played on the chancellor's boost for bingo players or focused on pension pots no longer having to be taken as an annuity. While the cut in bingo duty was genuine enough, nobody has been required to buy an annuity since 2006, although three-quarters of those retiring each year still do.

Pension regulations can be such an emotive subject that it's frequently difficult to see beyond the headlines. However, objective clarity and professional advice are more vital than ever as the relaxations announced in the Budget open up an array of options that offer potentially very significant tax savings for those who plan skilfully.

The proposed relaxations will increase the capped amount you can draw from a pension from 120 per cent of an equivalent annuity to 150 per cent, starting from the next scheme year. However, the biggest change will apply from 6 April 2015, when all limits will be lifted and you'll be able to draw what you like, when you like, from your pension. Indeed, you could draw down your entire fund immediately if you so choose (although you probably shouldn't, as I explain below).

Beyond a tax-free lump sum, you'll have to pay tax at your marginal rate on whatever you draw, at a rate of up to 45 per cent, with inheritance tax later on at 40 per cent on the balance unless you spend it. And people overspending their pension pots could create problems. The prospect of wealthy retirees withdrawing their entire pension pots has caused some to fear spending sprees on Lamborghinis and buy-to-let property.

Some of my clients have an aversion to leaving wealth in pension pots because of their funds' exposure to potential government rule changes. Even if they don't plan to splash out on cars or houses, their natural inclination is to withdraw funds from their pensions as soon as they can. However, I would caution against taking money out of a pension just because you can.

True, it makes sense to draw what you can at the 20 per cent tax rate and indeed use up your lower marginal income tax rates to avoid incurring higher tax on these sums in future. Beyond that, though, it will probably prove more tax efficient not to draw more than you need each year to cover your outgoings.

Indeed, you could achieve significant tax savings by not 'crystallising' your pension in full. If you instead stagger withdrawals over several tax years, you could avoid the penal loss of personal tax allowances and in addition avoid exposing large amounts unnecessarily to tax at 40 per cent or 45 per cent.

Leaving funds to grow uncrystallised can also provide you with a higher tax-free cash sum in time, although you need to bear in mind the lifetime limit on pensions of £1.25m (unless you have 'protection'). In addition, not drawing your pension before you're 75 can provide very significant tax savings for your family if you were to die prematurely.

New freedoms

You should consider two factors: the sustainability of your wealth to take you through retirement and how you can best use the new freedoms to manage your tax rate exposure efficiently.

Particularly if approaching retirement, you should also consider your pension in the context of your overall wealth, taking into account any property or other investments you hold. If other sources of income or capital - such as rental income or repayments of partnership capital - cover your likely outgoings and, if applicable, use your lower tax bands, it may be beneficial not to touch your pension at all for some years.

Planning your cash flow so that you draw from the most tax-efficient pot of wealth each year (not looking solely to the pension) will minimise both income tax and inheritance tax. Retirement cash flow modelling will also be essential to demonstrate the sustainability (or otherwise) of your asset base.

It's important to 'stress test' such projections against potential changes in expected returns and inflation, and to build in a sufficient buffer to cover unexpected expenditure. Such modelling will not only help you manage your income and minimise tax, but will also let you do so with the minimum disturbance to your pension funds.

As readers will infer, each person's pension and other financial arrangements are just that - personal. Now even more so, it is important to seek specialist advice.

Consultation on the new provisions lasts until June, after which legislation will be drafted to go live in April 2015. As ever, there are sure to be plenty of traps in the detail. However, the chancellor has let the pensions genie out of the bottle and it's hard to imagine how anyone would dare to try to put it back.

Paul Gauntlett is an executive director, specialist advice at Coutts

Coutts writes a regular blog for Private Client Adviser