As younger generations struggle to achieve financial security, more retirees are dipping into their pensions to provide a helping hand. From covering some day-to-day living expenses to offering a lump sum for a deposit on a first home, it might be something you’re considering. However, it’s important to take a step back and consider the consequences first.
Why are pensions increasingly being used to help out loved ones? There are two key factors that have led to this.
First, wages have been largely stagnant since the 2008 financial crisis whilst the cost of living has increased. As a result, children and grandchildren may be struggling with day-to-day costs or achieving life milestones. Getting on the housing ladder is a prime example. The average age of first-time buyers has increased and it’s predicted that one in three millennials will rent throughout their life.
Secondly, retirees can now take lump sums from their pension or an income that suits them. Pension Freedoms were introduced in 2015 which made Defined Contribution pensions accessible from the age of 55. Should you choose to, it’s possible to support loved with by taking money out of your retirement savings.
If you’re tempted to put dip your hand into your pension to offer financial support to loves ones, there are five things you should do first.
1. Understand your pension provisions
Do you know exactly how much your pension is worth? Or what sort of lifestyle this will afford you throughout retirement?
Before you start looking at how to support loved ones, you should assess how your current pension provisions will support you throughout retirement. This means looking at the value of all your pensions and the type that they are. It’s vital information for assessing if you should offer support and how much you can comfortably afford to give. You may, for example, be comfortable giving away a lump sum from a Defined Contribution scheme if you have a guaranteed income from a Defined Benefit pension that will cover your outgoings.
2. Assess the long-term impact on financial security
On the face of it, taking out a portion of your pension to give to loved ones may not have a significant immediate impact. But how will it affect your lifestyle in the medium or long term?
If you’re at the point of accessing your pension for the first time, it’s not unreasonable to expect your pension will need to provide an income for 30 or 40 years. As a result, it can be challenging to understand how making a withdrawal now will affect your financial security in the future. This is an area where cash flow planning can help you understand the full impact.
3. Calculate the potential tax liability
Taking money out of your pension may not be the most tax-efficient way to pass wealth to your loved ones. You’re typically able to take a 25% lump sum from your pension tax-free, but after this, any amount withdrawn will account as income for tax purposes. As a result, it’s important to consider how a withdrawal will affect your tax position now and in the future.
4. Check if you’ll be affected by the MPAA
Once you’ve withdrawn the money from your pension, do you plan to continue contributing to it? If you’re accessing your pension at 55, you may still have years of work left ahead of you in which you plan to continue paying into a pension. However, the Money Purchase Annual Allowance (MPAA) may have an impact.
Prior to accessing your pension, you can benefit from tax relief on contributions up to £40,000 a year, although there are circumstances where this is lower. Once you start taking money from your pension, this may be reduced to just £4,000 annually under the MPAA. It could have a serious impact on your ability to save efficiently in the future.
5. Discuss how the money will be used
Finally, you should discuss with your loved ones how the money given will be used. You may be happy to withdraw a £15,000 lump sum to act as a property deposit or pay school fees for grandchildren. But would you feel the same if it was going to be used for a holiday, for example? Having a conversation around what the money will fund and whether it’s a gift or loan is crucial for ensuring you’re all on the same page.
If you’re thinking about accessing your pension to help loved ones, please get in touch. We’re here to help you understand the financial implications of the decision and highlight the most efficient way you can lend support should you decide to proceed.
Please note: A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.
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