Since the introduction of pension freedoms in 2015, you can access your retirement savings in full from age 55. £6.7 billion was withdrawn from pension funds in 2017, the highest amount since the new rules were introduced. Alan Ferguson reflects on the pension freedoms and how we can help you provide for your retirement income in the most tax efficient way.
Remember the options
You can now access your pension pot in three ways:
- take a guaranteed income for life by securing an annuity;
- taking an income directly from your pension whilst the remaining fund is invested through a drawdown arrangement;
- or withdrawing the full pension pot as cash.
Generally up to 25% of your pension fund can be taken as a tax-free lump sum, but any further withdrawals by any of these options are subject to Income Tax.
The changing retirement landscape
Since the introduction of pension freedoms there has been a huge shift in the number of people choosing to take income through a drawdown arrangement rather than by buying an annuity. Our regulator, the Financial Conduct Authority (FCA) reports that twice as many people are now using a drawdown arrangement rather than securing an annuity – a reverse of what was the case prior to 2015.
The attraction of drawdown has seen many more people setting up drawdown arrangements without financial advice. Getting financial advice helps to ensure that drawdown is suitable for you throughout retirement and assesses the advantages and disadvantages of the options available.
Some lessons from pension freedoms
1. Are your investments tax efficient?
Withdrawing funds from your pension and reinvesting the money in other investments may not prove to be the most tax efficient way to get the most out of your savings. Your pension fund grows free from Capital Gains Tax and Income Tax and is generally free from Inheritance Tax in the event of your death. A cash-based investment, like a bank account, may offer low rates of return and will potentially add to the Inheritance Tax bill.
2. Taking large cash sums from a pension pot
Once you have taken 25% of your pension fund as a tax free lump sum, any further withdrawals will be treated as taxable income. Large lump sum withdrawals can therefore result in a higher that expected tax bill as these amounts will be added to all of your other income in the tax year, potentially moving you into higher rate tax bands.
3. Providing income throughout retirement
Withdrawing your entire pension pot as cash raises concerns about providing future retirement income, as your pension pot has been used up. It is important to ensure that it will not impact your future quality of life. Reassuringly the FCA review found that 94% of consumers who had taken their full fund as cash had other sources of retirement income in addition to the State Pension. You can obtain a State Pension forecast online at www.yourpension.gov.uk. Your State Pension forecast will show you what you might receive and when these payments may start, but values or dates are subject to change.
An annuity gives a guaranteed income for life, so this will provide reassurance of having a stable income throughout your retirement. But you need to consider the impact of inflation and how to best manage other investments which may be needed to provide any additional income.
The level of income you take from your fund in a drawdown arrangement also needs to be extremely carefully monitored, as your remaining funds are also subject to investment risk and will rise and fall when financial markets experience volatility.
The value of advice
Our advice provides a full review of your financial plans so that you can make the most of the options available. We will assess how best to provide your required level of retirement income as tax efficiently as possible, whilst considering your future needs.
Even some simple planning such as spreading cash withdrawals across tax years can help to ensure that you receive more from your retirement fund and reduces the tax you need to pay.
If you have yet to take your pension, we can help you to review your retirement plans and how best to provide the income you will need. It is important to fully understand how drawing from your pension fund may impact on your longer-term financial goals. We will also consider other tax efficient strategies such as ISAs and using your Capital Gains Tax allowance.
A blended approach of part annuity and part drawdown is also an option. Whatever route you follow it requires a regular financial review to ensure that your plans remain suitable for your financial goals.
We recognise that a pension fund can be very effective at preserving your wealth from Inheritance Tax on death. By organising a Power of Attorney (see last month’s Financial Update – at using your powers-responsibly), you can prepare your beneficiaries for managing your portfolio if you are no longer able to do so.
Making decisions on you retirement income has wider consequences on your overall financial planning. Please contact your Origen adviser or call us on 0344 209 3925* to get a thorough review of your retirement income needs.
*Calls are charged at your phone company’s basic rate. All calls are recorded for business purposes.
This artical is for information only, based on our understanding as at January 2018 and is not to be taken as Financial Advice.
CA4047 expires 01/02/2020