Enjoy Flexible Income in Retirement – But Don’t Lose Focus on the Taxman
Upon reaching 55 pensioners now have full access to their Defined Contribution pension pot meaning they could withdraw all of their money in one go.
Is this too good to be true? In this article Brian Davidson of Alliance Trust Savings considers the benefits of keeping monies within a pension rather than simply withdrawing it all.
Remember the taxman
Why do people invest in pensions rather than other vehicles when it comes to saving for their retirement?
The principle reason people save for their retirement via a pension is the tax efficiency both from a savings and income perspective.
Tax relief on contributions gives retirement savings a boost while the tax free lump sum at retirement is probably one of the most popular features of pensions – a 25% tax free lump sum can be taken from your pension.
The key point to remember is that any further income you take is subject to income tax at your marginal rate(s).
No matter how you take an income whether it is via regular payments or more ad-hoc larger payments it will be taxed at your marginal rate of income tax (subject to personal allowances).
The potential tax trap is that by taking all or large sums of monies from your pension in the one tax year your marginal rate of income tax on that lump sum can increase significantly from their normal rate of tax.
‘Before taking income from your pension complete a review of all of your savings’
This means that by taking a lump sum your marginal rate of income tax could increase meaning you could move from the 20% tax bracket to a 40% or 45% bracket.
There are also other benefits to keeping monies within a pension. These include:
- No Capital Gains Tax within a pension wrapper
- Normally not subject to inheritance tax
The new flexibility being proposed is to be welcomed, but it is worth remembering some golden rules:
- If you are reliant on the monies within your pension to sustain your lifestyle then it is likely you need the monies to last until you die.
- Consider your dependents – If you die will these monies be required to fund a loved one’s retirement.
- Consider how secure the other forms of income you receive are? Are they dependent on investment performance or are they secure?
- Before taking income from your pension complete a review of all of your savings. Only by understanding your current level of savings and income can you make a decision on what income you need from your pension.
- Consider consolidation – Prior to taking an income from your pension many clients consolidate the various arrangements they have into one, increasingly into a Self Invested Personal Pension (SIPP) due to the investment and income flexibility offered. By consolidating you can often reduce the impact of charges on your pension savings.
- Consider the retirement income that you will need – short, medium and long term. Remember, when it is gone it is gone!
- It is not the end of annuities – many people will quite rightly still be attracted to a fixed income for the remainder of their life.
- You don’t need to have all the answers. Taking a retirement income is one of the most important financial decisions you will ever make and therefore don’t be afraid to seek professional financial advice even if you normally regard yourself as a DIY investor.
So, now that you access to your whole pension pot, a Ford Focus* and sustainable retirement income may make more sense than a Ferrari sitting in the drive!
* PS (Before readers take offence Brian Davidson Platform Proposition Manager at Alliance Trust Savings is a proud owner of a Ford Focus)