So what are your choices?
You now have a choice between taking an annuity, withdrawing lump sums or accessing your pension funds through Flexi Access Drawdown. You can access your pension from 55 years of age. Annuities are proving less popular at the moment due to low annuity rates and because they are not particularly flexible. They do however offer a guaranteed income for life so are still attractive to the right person. Flexi Access Drawdown allows you to take whatever you want whenever you want it from your pension fund. Whilst this may sound very appealing there are a couple points to consider. For example, what level of income tax will you pay? Could you deplete the fund too quickly and risk running out of money?
With annuity rates continually being so low, flexi-access drawdown has proved extremely popular with consumers. Some £2.3 billion was withdrawn from pension funds using this method in the first quarter of 2018/19 tax year. This is a whopping 50% increase from 2015 when it was introduced (source; Money Observer)
The way it works is relatively simple. You withdraw funds from your pension, either as an income or lump sum payment and the remainder stays invested to grow. Up to 25% of the fund is payable tax-free and 75% is taxable. However, the thought process and practical application may not be so simple. You will have to choose the amount you take and the investments you use. This will determine how sustainable your income level will be and will require careful planning.
We strongly recommend that you calculate your income and expenditure requirements including any one-off payments. Our advisors can then use software to forecast the level of income you require and how this can be achieved. This will incorporate certain assumptions including future fund growth and the level of inflation. We review the plan regularly to take account of any financial changes that occur along the way.
Planning your pension income can also help minimise your tax liability by using your available allowances. Let’s say that a retired married couple require £33,000 per annum as an income (assume they have not reached state retirement age, no other income and both have sufficient funds within their pensions)
£25,000 income will have no tax liability as this is their combined personal allowance (2 x £12,500)
£8,333.33 income which represents 25% tax-free payment
£33,333 Total
Therefore, in this example, withdrawing £33,333 per annum collectively from both of their pensions would not incur a tax liability. You have various choices as to how to withdraw money from your pension and bdhSterling can recommend the most suitable method based on your individual circumstances.
Inheritance tax
For those of you who are concerned about how much inheritance tax your estate will have to pay, there is good news. Pension funds usually fall outside of your estate for inheritance tax purposes.
The current rules mean that if you pass away under the age of 75, your beneficiaries will receive your remaining pension fund totally tax-free. In most cases, they can take the total fund value as a lump sum with no tax liability.
If you pass away after your 75th birthday, your beneficiaries will pay tax at their marginal rate of income tax. It is worth noting that if some of the beneficiaries are non-taxpayers, they will not pay any tax if they withdraw funds up to their personal allowance. Depending on the financial situation of the beneficiary, they may decide not to withdraw any of the funds and instead keep it in trust for their children. This would be paid tax-free if the beneficiary later passed away under the age of 75 years. This is a very effective way of passing wealth to future generations.
The choices that you make now will ultimately decide what sort of retirement you can look forward to. Whilst pension freedoms are designed to simplify matters, it is easy to trip up.
Careful planning will help you reach your goals and ensure you have a retirement to look forward to.
If you would like to discuss your circumstances in a free initial consultation, then please contact bdhSterling at infoUK@bdhsterling.com or on 01372 724 249.
This article shouldn’t be taken as financial advice and is based on our understanding in May 2019. The Financial Conduct Authority does not regulate Cashflow Modelling or Inheritance Tax Planning.
