Freedom of Choice

In April 2015 the Government made significant changes to the ways that people in certain types of pension schemes can take their pensions. 

Who is affected?  

The changes are mainly aimed at members of Defined Contribution (DC) pension schemes, sometimes also referred to as Money Purchase Schemes.

Members of Defined Contribution schemes build up a pot of money consisting of their own contributions and any contributions that their employer may have paid in.  This money is then invested and the returns from that investment are also added to the pension pot and re-invested.

Traditionally when a person with a Defined Contribution pension retires they have generally been required to use the money they have built up to buy an annuity.  The annuity is an income for life paid by an insurance company and the bigger the size of the pension pot at retirement a person has the bigger the annuity they can buy.     

It’s important to be aware that the Local Government Pension Scheme (LGPS) is not a Defined Contribution Scheme, so many of the changes that took place in April 2015 do not apply directly to members of the LGPS.

Freedom and Choice

The biggest change from April 2015 is that members of some DC pension schemes will no longer have to buy an annuity.  Instead they will have what the Government refers to as “freedom and choice” over how they use their DC pension pots.  People with these types of pension schemes will now be able to use their pension pots in any of the following ways,

1) To take an annuity in the same way as before

2) To take their money as cash, either all at once or in a series of separate instalments

3) To take a mixture of 1 and 2 above, i.e. to buy an annuity with some of their pot and take the rest as cash when they wish

Where members choose to take their pension pots as cash the first 25% of that cash is paid tax free and the rest is taxed in the same way that any other income, such as a salary, is taxed.

What about the LGPS?

The LGPS remember is not a Defined Contribution Scheme, so members will not be able to take all of their benefits as cash in the same way as members of DC Schemes can.

The LGPS is a defined benefit pension scheme.  In this type of scheme the benefits you get at retirement don’t depend on how well your investments perform or how large an annuity an insurance company will sell you.  Instead your LGPS pension at retirement is based on how long you’ve been in the scheme and how much you have earned.  This means your benefits are secure and predictable. 

The LGPS also has a feature that allows members who are retiring and want to have access to additional cash, to swap some of their pension for a bigger lump sum.  At retirement you can usually take a lump sum up to 25% of the total value of all your LGPS benefits which is paid tax free.