With great change comes responsibility.

As you might have heard in the press, 6 April 2015 saw the most radical changes to private pensions for a generation. The way you can spend your retirement income is now much more flexible. If you’re over 55, rather than having to buy an annuity, you can now take as much or as little of your fund as you want, or even take the whole amount as a lump sum.

There are now three ways you can access your retirement income:

    This will give you a regular guaranteed income that will be paid out to you as long as you live.
    Flexi-access drawdown enables you to take lump sums and regular withdrawals as and when it suits you. 25% of each amount you move into Fad can be paid out tax free; any income you take from the rest will be taxed.
    This is by using an uncrystallised funds pension lump sum. 25% of this payment will be tax free, but the remainder will be taxed as income.

Why are these changes a good thing?

The pension reforms have been widely welcomed because the need for more flexibility around how we spend our money at retirement has never been greater. Improvements in health mean that we're all living longer - today's 65-year-old has a good chance of living another 25 years. So the traditional image of the old age pensioner has radically changed from the idea of it being a little old lady settling down to a life of Horlicks and bridge to something much more active and varied. Retirement now can be the start of a whole new life stage - whether it's re-training, travelling the world, or starting up your own business.

However, more choice can sometimes mean more complexity. There have been reports in the press of a widespread confusion caused by the changes - with people as young as 23 trying to withdraw their savings. Just as worrying is the lack of awareness among the public around the potential tax bills they could receive if they remove their cash all at once.

How much could the tax bill be?

If you cash in the whole of your pension, you could pay up to 75% tax on all of it. When added to any earned income you have for that tax year, this may push you up into a higher tax bracket - for example paying 40% or 45% tax. You may also find that you lose some of your personal allowance if your total income, including the pension lump sum, is above £100,000.

Case study - Heather

To illustrate this example, let's take a look at Heather, a 57-year old estate agent who earns £27,000 a year.

Heather has a personal pension worth £48,000 that she would like to cash in. She will take 25% of this pension as tax-free cash leaving a residual fund of £36,000.

If she takes the whole residual fund in 2015/16 then adding this to her earned income it will push her up into the 40% taxpayer bracket, and she will have to pay an additional £11,323 in tax - an effective tax rate of 31% on the pension.

However, if Heather splits her pension fund over three tax years and takes £12,000 in 2015/16, 2016/17 and 2017/18 she could reduce this. Assuming that her salary and the personal tax allowance remain constant she would pay an extra £2,400 tax each year, retain a 20% tax rate, and save £4,123 in tax.

Even if Heather needed the money quicker than that and decided to cash in her pension fund over 2 tax years, she would pay an extra £4,123 in years one and two - an effective tax rate of 23% on the pension, and save £3,077 in tax.

This case study is for illustrative purposes only and does not constitute advice.

Speak to your financial adviser

As you can see not all change is straight forward. With more lifestyle choices open to people approaching retirement there's a real need to make sure you have the right amount of money to do exactly what you want at retirement. That's why it's important to speak to your adviser before making any decisions.