Six things to know before drawing your pension
A record number of people are reaching retirement age this year. According to The Telegraph1, an incredible 169,000 more people have reached, or will reach, their 65th birthday this year than last, and this trend looks set to continue.
An enjoyable retirement relies heavily on being financially prepared. Our recent ‘What’s your number?’ report found that the top priorities for people reaching retirement are ‘not to have to worry about money’ and ‘to maintain my current standard of living’. While achieving these goals will largely come down to how much you have saved, there are also some very important things you need to be aware of before accessing your pension savings:
1. Your pensions savings won’t automatically pay you an income
Unless you are lucky enough to have a final salary pension, you will need to decide how you are going to turn your pension savings into an income. There are several options available to you, from an annuity that offers you a guaranteed fixed income for life, to a fully flexible income drawdown product that offers no guarantees but lets you take as much income as you like, when you like. Then there are products that offer you a combination of these two approaches.
Deciding what is right for you is not easy. It can depend on many factors such as your health, the age you are when you start accessing your pension savings, and how much you have in the way of other savings and investments.
This is complicated stuff and requires careful thought. If you don’t have a financial adviser, now is a great time to get one, even if you don’t feel you have enough savings to justify paying for advice.
2. You still pay income tax on your pension withdrawals
It can come as quite a shock to find you will continue to pay income tax in retirement. The good news is that you’re allowed to take 25% of your pension pot tax-free at any time after you are 55 years old, either as one lump sum or as smaller amounts over many years. After that, any money taken from your pension (either as a lump sum or as income) will have income tax deducted.
The tax thresholds are the same as when you were employed and will depend on how much income you ‘earn’ in any given tax year, including other sources of income, such as a rental property.
3. Be careful of the lifetime allowance
The Government has limited the amount of pension savings you can accrue over your lifetime to £1.055 million (tax year 2019/20). While this may sound like a large sum of money, you would be surprised how many normal hard-working people manage to save this amount during their working life – especially since it includes the investment returns their savings will have achieved.
If you find your pension savings have amounted to more than £1.055 million, you will need to tread very carefully to minimise your tax liability. For any amount you withdraw over this allowance, you will be taxed an extra 55% on that withdrawal if it is a lump sum, or 25% if it is drawn as an income.
If you have not made any pension contributions since April 5th 2016, you can at least partially protect yourself from this charge by taking out locks in the old £1.25 million lifetime allowance, saving you an unexpected tax bill of over £100,000. The only drawback is that if you take this protection you will not be able to make future contributions to your pension.
4. It might pay to delay accessing your pension savings
Many of our clients are delaying accessing their pension savings and drawing on other savings and investments first. Why? Because if you die before you are age 75, any money left in your pension can be passed on to your beneficiaries without paying inheritance tax. If you are over age 75, then it will be taxed at your beneficiaries’ income tax rate, which might be less than inheritance tax if they are a lower rate taxpayer.
5. Taking money from your pension can restrict future contributions
If you think you might want to make new contributions to your pension in the future, be aware that as soon as you take money from your defined contribution pension, or if you move it to an income drawdown product then take an income, you could trigger a lower annual allowance of £4,000 for new contributions. This is known as the Money Purchase Annual Allowance (MPAA) and means you will only receive tax relief on pension contributions of up to 100% of your taxable earnings or £4,000, whichever is lower.
You won’t trigger the MPAA if you take a tax-free cash lump sum at retirement and buy an annuity, or if you put your pension pot into an income drawdown product in order to access the tax-free lump sum, but don’t take any income from it.
6. You will need to prepare for unexpected expenses
Our research study asked 250 financial advisers what is most likely to have a negative impact on their clients’ long-term wealth. Over a quarter (28%) cited unexpected care costs, 25% said excessive spending, 24% said supporting parents and/ or children, and 20% said divorce.
A good financial adviser can help you prepare for such unexpected costs, ensuring they don’t impact on your ability to enjoy retirement.
There’s more to withdrawing your pension savings than meets the eye. It’s very easy to make decisions early on in retirement that you live to regret for years to come. That’s why we believe so strongly in taking financial advice at this juncture in your life – even if you have managed your own finances up until now.
If you don’t want to seek help from a financial adviser then please do get in touch with the Pensions Advisory Service. They offer free and impartial guidance to people with workplace and personal pensions.
For information only, not to be considered financial advice. Based on our understanding of HMRC rules as at December 2019.