By BRENDAN COBURN, financial planner at Essential Money
The new pensions freedom rules arrived in April and with them an awful lot of noise around the subject.
Those approaching retirement age were warned of con artists trying to liberate them of their pension pots, while at the same time being cast as feckless enemies of the state – what if they drew all their pensions in one go and blew it on fast cars, expensive holidays and parties before relying on the state in their old age?
Here are some of the facts surrounding the changes and what to watch out for.
The con artist
Someone once said that common sense is not always common practice so, to state the obvious:
- If it sounds too good to be true it probably is
- Never agree to anything from an unsolicited phone call
- Check the Financial Conduct Authority register to see if the person you are speaking to is authorised to provide advice
- Ask for a breakdown of the charges in writing
- If in doubt seek a second opinion
Can I draw all my pension fund out in one go?
As regards NHS pensions, you can no longer transfer the benefits to a defined contribution scheme – more commonly known as a personal pension. As regards any personal pensions you have, yes you can draw out all your pension at retirement age, but as ever the devil is in the detail.
The first 25 per cent of your pension pot is called the Pension Commencement Lump Sum (PCLS) and is traditionally known as the tax free lump sum. However, the remaining 75 per cent of your pension pot is taxable at income tax rates after taking into account any other taxable income you may have in that financial year.
This is a very important point since the amount of tax you pay could be 0 per cent, 20 per cent, 40 per cent, 45 per cent or even 60 per cent (on a portion between £100,000 and £121,200) depending on how much you take out of your pension fund in one tax year and the level of other income you may have.
For example, someone with a pension pot of £100,000 who decides to take all the fund out in one financial year would receive £25,000 as a PCLS and thus tax free but the remaining £75,000 would all be subject to income tax rules.
This would mean that assuming they have no other income for the year and after utilising the Personal Allowance of £10,600 (2015/16) they would pay income tax of £19,403 as £32,165 of your taxable fund would be taxed at 40 per cent and the remainder at 20 per cent.
The result is that the pension fund you would receive after tax is paid would reduce from £100,000 to £80,597.
Even worse, if the taxable portion of your pension fund when added to any other taxable income for the year was greater than £100,000, you would also lose your Personal Allowance for that year, resulting in more of your fund becoming liable to income tax.
Take enough but not too much
So what should you do? Well unless you really need all of your cash in one go for a specific reason then it will be more reasonable and tax efficient to sit down with a financial planner and establish how much income you will need year on year.
You and your adviser can then look at your pension and other assets and investments such as ISAs to see which is the most tax efficient method of providing for that income, perhaps from a combination of tax free cash, ISAs and taxable pension income.
Part of this planning process is to ensure that you don’t take too much out early on, leaving you with little or no income in the later years of your retirement. Equally important is to avoid not spending enough because of the fear you will run out of money. This would mean you were not doing what you want to do in the early years of retirement when you are young and fit enough to enjoy them.
So planning helps to ensure the two extremes can be avoided.
If you take it spend it
Funds in a pension enjoy some valuable tax benefits. As well as all growth in the fund being tax free, it’s also usually free from inheritance tax if you die before taking a pension income. Additionally, the fund can be returned tax free to your beneficiaries if you die before 75.
However, if you just draw out your pension because you can and simply leave it in your bank account then these tax benefits are lost.
Pension freedom’s not for everyone
Although one of the main drivers for pension freedom was the poor value for money that annuities were providing, this does not necessarily mean this route is for everyone.
There will still be a sizeable number within the retiring population who would prefer the surety of a fixed income from an annuity that they can rely on for the rest of their lives without the worry of running out of money.
I strongly recommend taking independent financial advice before taking your pension, especially when you consider that most people will live for at least 20 years in retirement. The decisions you take regarding your pension now could determine the quality of life over the next 20 years and we can help ensure you avoid having any regrets about what could have been.
Essential Money is a leading specialist Independent Financial Adviser for dentists in the UK. For more information visit www.essentialmoney.co.uk