pensions and investments
Pensions, what should I do?
Words by David Dolman
I think it is safe to say that pensions are one of the most important elements of our own financial planning but can also be the most confusing. With continuous rules changes, taxation and age changes, it can be difficult to know where we are and so many of us simply bury our heads in the sand. The truth it, there isn’t a one size fits all answer and each and every one of us will have a different set of circumstances, needs and plans for when we retire. My suggestion is to sit down with an adviser and look to have a bespoke plan created for yourself as this is most likely to give all of the answers that you are looking for.
Below I try to answer some of the most common questions I get asked when it comes to pensions.
Should I take some of my pension now?
You will begin to see that as with all questions on pensions and other financial planning, this may seem like a straightforward question but, in reality, there are many answers to this. The answer will undoubtedly be different for everybody and will depend on a number of factors. It is impossible to answer this question here but let’s explore some of the considerations:
What age are you?
So, this is the easiest to answer simply because if you are not age 55, then you just cannot access money from your pensions. This age is due to rise to age 57 from 2028 and likely further as the State pension ages rise. There may be a very few exceptions to this but again, this is where we are all different as with pension schemes etc.
Are you planning to retire now or are you still working?
As mentioned in the above point, many people can access their pensions from age 55 but, in reality, very few will retire at this age. So you need to consider what impact withdrawing funds from your pension will have on your retirement.
Consider this – you have £200,000 in your pension at age 55. You do not plan to retire until age 65. If this £200,000 were to achieve a compound interest rate of 5%pa then the value at age 65 would likely be around £325,000.
Now consider that you decided to withdraw 25% of the fund at this point leaving you with £150,000 invested. With the same 5% pa compounded interest, you’d now be looking at having around £244,000. You can see here that whilst you have had £50,000 and spent it, in reality the loss could be significantly more. In the region of £81,000.
Do you have a family. Spouse, children or grandchildren etc?
Again, this is a personal circumstances question. You should consider your overall assets when deciding where to withdraw money from.
Currently, pensions are able to be passed through generations without paying any inheritance tax (currently levied at 40%). Therefore, you should consider using less tax efficient assets in the first instance if you think IHT may be an issue.
Do you need to take money out of your pension?
As seen in the earlier example, taking money out of your pension early or taking too much out at a time can have a significant impact on the final value of your pension when you do retire. Therefore, consider whether you really do need money from your pension or are you acting on an impulse. Is it worth that longer term blow to your finances?
Should you in fact be looking to pay more in rather than taking money out?
As I write this, pensions are amongst the most tax efficient savings vehicles for residents in the UK. As a UK taxpayer, you are able to receive tax relief on money paid into your pension. If you are approaching retirement, is now the time to be using other savings you may have and spare income in order to boost your pension fund in the final years.
See this example:
You have £10,000 in surplus savings which you decide to pay into your pension. The pension provider would automatically reclaim 20% tax on your behalf and if you are a higher or additional rate taxpayer, then you could be eligible to reclaim further tax.
£10,000 + tax Reclaim = £12,500 paid into pension
Potential further tax reclaim of:
£2,500 for higher rate taxpayer
£3,125 for an additional rate taxpayer
What do I do with my Final Salary pension
Quite honestly, in the vast majority of cases it is best to keep your final salary exactly where it is and begin receiving the income from it at your specified retirement age.
Final Salary schemes are considered to be the best option for most individuals (provided you are in the fortunate position to be offered such a scheme.) these will guarantee you a level of income for the rest of your life, no matter how long you live. Many schemes have other benefits such as spouses pensions and minimum yearly growth on the income level. The key is that there is no danger with these schemes that you take too much income too soon and run out before your death.
There are other options with these such as being able to transfer into a personal pension which would allow a more flexible approach to how and when benefits are taken from the plan. However, this is a extremely specialist area of financial advice and many schemes would require you to seek personal financial advice before they would allow such a move.
How much do I need in my pot?
You won’t be surprised to find out that again, this isn’t a straightforward question either. There are many factors to consider when thinking about this, namely, how much does your lifestyle dictate that you will need in retirement.
Sure, we will all have bills to pay in retirement, groceries, council tax, rates etc. and many of these will be in a similar range. Hopefully, we will have a mortgage paid off before retirement, thus reducing the amount of income we need. But really, its everything else on top. Are you happy with a modest lifestyle with the odd holiday here and there or are you a jetsetter looking for 4 holidays per year and being at the golf course 4 days a week. You can imagine that the spending in these two examples are going to be wildly different.
Once you have thought about how the ideal retirement looks for you, you can then begin to work out how much you will need but, even then, it isn’t as simple as that. To work out how much you’ll need in your pot, you will need to consider many other aspects; what income will you have from other sources, what other assets do you have that can be taken into account, what age would you like to start taking an income, do you have financial dependents. The list goes on…
Let’s say after all of this, you arrive at a figure of £25,000 income needed from your pension alone, we should easily then be able to calculate a target shouldn’t we? Well, this will then depend on how you are looking to draw the income. What is you attitude to risk and capacity for loss? If low, you may want to consider an annuity, if higher, do you use drawdown or do you go for a blended approach?
When drawing funds via drawdown, you need to consider how the amount you draw will deplete your fund over time and therefore how long it will last. As a general rule, you shouldn’t really draw more than 4-5% pa from your pension fund. If you draw more than this then you are far more likely to run out of funds too early. Also consider that if you are retiring earlier, for example 55 or 60, you would want to consider taking less than this given that the funds need to last that much longer.
So the answer, for an income of £25,000pa, you might be looking to have a fund of between £500,000 and £625,000 as a guide.
Annuity rates will vary yet again and can depend on many factors. To get an idea of what annuity your fund would purchase, visit the money advice service https://www.moneyadviceservice.org.uk/en/tools/annuities
What taxes will I pay
So, this is perhaps an easier question to answer. It is again dependent on individual circumstances but there are very clear rules on how much tax you will pay on your pension income. Pension freedoms introduced in the UK in 2015 have made it much easier to take as much as you like from your pension, in fact, you could have the whole lot if you wanted. But beware as this could well come with a hefty tax bill.
Put simply, any withdrawal from a UK Defined Contribution pension will be tax free for the first 25%. The remaining 75% will be taxed at the recipient’s marginal rate of tax in the corresponding year taking into account income received from all sources.
As at the 2020/21 tax year – an English resident has a £12,500 per year personal allowance on which no tax has to be paid. Therefore, there is a potential to withdraw £16,666.66 from your pension each year without needing to pay any tax (assuming you have no other income in the tax year). It is however likely that most of us will have other sources of income, courtesy of the State Pension, currently £9,110pa in 2020. This means that you will be using up a good portion of your personal allowance with the State Pension.
Any income drawn that takes an individual over £12,500 for the year will then be taxed at the basic rate of tax, currently 20% and when that income moves above £50,000, tax will be levied at the higher rate of tax, currently 40%. National Insurance is not payable on income taken from a pension.
t is important to note that the information on taxes is correct for the 2020/21 tax year and is subject to change in the future. The rates illustrated are for England and Wales and do not include Scotland. In Scotland, the concept is much the same however, the government there have introduced different tax bands to England.
To bring all of this together, I would urge you to consider everything we have spoken about here but it is important to realise that each and every one of our circumstances will differ to some respect. There is no one size fits all answer but there will be an answer individual to you.
In order to understand how to make the best of your own situation, it is important to seek financial advice to ensure that this is tailored to you. Don’t leave it to chance.
This article does not constitute financial advice of any kind and is simply for information only purposes. Should you wish to discuss any of this in more detail, please contact me on 0771 343 0539 or David.Dolman@sjpp.co.uk and I would be happy to help.
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