Are You Missing Out on the Advantages of Pension Freedoms?
It can seem like we work our entire lives, but retirement comes faster than you think.
The average person works around forty-five years of their life and then relies on a pension for another twenty-five years. That means the money you save towards your pension needs to go a long way.
Whether you have multiple company pensions, a final salary scheme or a personal pension, if you take advantage of all the benefits available to you, your retirement fund could be larger than you think.
Below, we discuss the available options and the potential benefits to you and your family.
As a working adult in the UK, there are three types of pension you can pay into. There’s your state pension, which is a weekly lifetime benefit paid out to retired citizens. The amount paid out is based on how many years you’ve paid National Insurance contributions throughout your working life.
There are the various company pensions you and/or your employer may have contributed to during your working life. Plus, there are personal pension plans you may have been utilising to save towards your retirement.
One of the first things to do when starting to plan seriously for your future is to take account of all your pension pots.
Income drawdown carries significant investment risk as your future retirement income remains totally dependent on your pension fund performance. Pension drawdown may only suit a limited number of people.
There are also the relatively new pension freedoms to consider, plus the many tax efficiencies you should be taking advantage of.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
In what follows, I outline a summary of all the options that have been available to you since 2015.
Pension Freedoms
In April of 2015, several different options to access your pension funds became available. You can choose to leave your pension untouched, purchase an annuity, use flexi access drawdown to design an adjustable income, access your money in large withdrawals, or cash out altogether.
Using your pension money will leave less money invested in your pension, and will have an impact on the money you’ll have through retirement.
Under the previous regulations, only one dependant of the pension plan holder could inherit a drawdown pension on the plan holder’s death. Commonly known as a “widow’s pension”, widowers, civil partners and a single named child could also inherit, putting the plan holder in a difficult position if they had more than one child.
Many still believe that this is the only way their pension savings can be passed on in the event of their death.
However, alongside the more familiar changes to the retirement regime, the reforms heralded significant changes in how pension death benefits are taxed, bringing with them new inheritance planning opportunities.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
Passing on Your Wealth
It is now possible for the plan holder to pass their pension on to any nominee – or a number of nominees – through something called Nominee Flexi-Access Drawdown.
Further, when the nominee dies, a successor – or successors – can also inherit a drawdown pension through a Successor Flexi-Access Drawdown. In turn, each nominee or successor can pass the assets on to other nominees or successors, retaining the tax efficiency of the plan through multiple generations.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
Taking Advantage of Tax Efficiencies
The key benefit lies in retaining the assets within a pension wrapper: in this way, they fall outside of the plan holder’s assets for Inheritance Tax (IHT) purposes. And as long as they remain within the wrapper they retain their full tax advantages until they are needed by the nominee or successor.
If the plan holder – or a nominee or a successor – dies before the age of 75, not only are the assets passed on free of IHT, but the drawdowns are paid out free of income tax. If they die after the age of 75, the assets are still excluded from the estate for IHT purposes, but any lump sums or income drawdowns are treated as income and subject to the beneficiaries’ personal tax position (i.e. taking into account other sources of income).
Not every pension plan is required to offer you these choices. If your various pots do not offer you these choices, you could be missing out on significant benefits. It is important to note that most of the existing pension plans were set up before the new regulations came into force and may not have the flexibility to establish Nominee or Successor Flexi-Access Drawdown accounts.
Instead, the pension provider will pay out the full value of the fund in cash on the death of the plan holder. In that situation, the assets count towards the total estate for IHT purposes and the tax benefits are lost.
So, it’s more important than ever to make sure you understand exactly what you can and cannot do with your current pension pots.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
Here’s a brief summary of the possible tax efficiencies you could benefit from:
Tax-free lump sum
You can take a tax-free lump sum of 25% of your total pension pot. With the rest, you can either buy an annuity or reinvest it and draw an income. Alternatively, you can withdraw the full pot as cash and pay tax on the other 75%, or delay taking it so it remains invested.
Another option is to take smaller amounts on a more regular basis and leave the rest untouched. Each time the first 25% is tax-free, but you pay tax on the balance. In this case, your pot isn’t reinvested.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
Personal allowance
For anyone earning up to £100,000, you don’t pay tax on any form of income up to the personal allowance of £11,500 (in the 2017-18 tax year). This allowance is reduced by £1 for every £2 earned above the threshold.
So, when you stop working and start drawing pension income, you won’t pay tax on it until the payments exceed your personal allowance. However, as long as you’re still employed, even in a part- time job, your earnings eat into your allowance. The tax-free lump sums discussed earlier don’t count towards your personal allowance.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
Individual Savings Accounts (ISA)
If you decide to withdraw a lump sum, one option is to put it in a cash or stocks and shares ISA. ISAs are tax-efficient accounts which protect returns (interest earned in a cash ISA, and gains and income generated by a stocks and shares ISA) from income tax and capital gains tax. The annual ISA allowance of £20,000 in the 2017-18 tax year may come in handy if your pot is big enough.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
The value of your investments and any income from them may fall as well as rise and is not guaranteed. You may get back less than you invest. Stocks and shares ISAs are considered medium to long-term investments and you should be prepared to invest for at least five years.
Dividend allowance
You can earn dividends tax-free on investments you hold outside your ISA thanks to the annual dividend allowance. This is £5,000 for the 2017-18 tax year, although it falls to £2,000 from April 2018.
Personal Savings Allowance (PSA)
You can also take advantage of the PSA for any savings you have outside a cash ISA. Basic rate taxpayers can earn £1,000 in interest tax-free and higher rate taxpayers can earn £500. Additional rate taxpayers don’t get a PSA.
Regardless of your current circumstances, whether you’re twenty or ten years away from retirement, meeting with a financial advisor can put you on the right track to a secure future.
Take the first step, and get a free pension audit from one of our expert advisers. We will go over your existing retirement provisions, making sure you understand your current choices, identifying any possible benefits available and make recommendations immediately.
Take control of your future, and let us help you create a roadmap to a happy retirement.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
