How to benefit from a new pension tax break

If you've been thoroughly confused by the recent changes to pensions, hold tight but the government has just come up with a third way to take your retirement income.

There are now three ways to get your hands on your pension income now but don't worry, it's not as difficult as you think – you just need to know when you'll need the money and what taxes you want to avoid.

The first way is still the most simple way: buy an annuity. This will give you a guaranteed income for life, with the first 25% of the cash tax-free, although the money will be lost to the insurance company if you're unlucky enough to die too early.

The second way is drawdown, which involves leaving your money invested, taking your tax-free cash and then taking an income which is taxed. Or you can use drawdown to take the lot but you'll pay income tax on everything after the first 25%. If you don't take all the cash, your pot of money can pass to your family less a 55% tax charge.

The third way –snappily titled 'uncrystallised fund pension lump sum' - is a slight tweak on drawdown. You can leave your money invested, and every time you take a chunk of cash out, the first 25% is tax-free and the rest is liable to income tax.

This is different to drawdown is that the first 25% of money taken from drawdown is tax-free where your tax-free cash under the third way is taken in increments. This has the advantage of leaving your remaining pot of money 'uncrystallised' which means if you die with money left it passes to your family tax free - which is a neat little tax break for those worried about estate planning.

Tax break

This third way will appeal if you want to leave as much money as possible to your loved ones when you die and aren't too worried about tax-free cash. This third way may also be cheaper as it doesn't involve buying a drawdown policy. Although the details haven't been fleshed out yet, it is expect that pension providers will allow retirees to pick the third way for their pension for a nominal fee and the money will continue to be kept in a pension-type arrangement.

But before you worry about the technicalities have a think about what your pension is for, what you want to take and what you want to leave behind – these are all far more pressing questions that only a decent financial plan can answer.

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