John Glen, economic secretary to the Treasury, spoke to the Work and Pensions Committee about Pension Freedoms recently, calling the legislation “a success”.
Introduced in 2015, the scheme allows those over 55 (rising to 57 from 2028) the chance to release the whole of their defined contribution (DC) pension funds in one go. At the time, it was feared that this would lead to poorly managed pension funds and retirees running out of money.
While this has largely not been the case, the Pension Freedoms policy has made budgeting harder and led to tax issues for some.
Professional pension advice can help to mitigate the risks of taking your pension under flexible rules, often earlier than originally planned. Here are some of the common issues you might face and how Boolers can help.
Pension Freedoms made several new options available
The traditional retirement choice was once an annuity – a regular income paid to you for the rest of your life on a basis you chose. Flexibility offered new ways to access your funds.
Flexi-access drawdown allows you to withdraw funds from your pension as and when you need them. The rest of your pot remains invested and so can grow, as well as fall, in line with market movements.
A lump sum
You can take all your pension as a lump sum, or a series of lump sums. You can usually take 25% tax-free, with the rest taxed at your marginal rate.
A mixture of options
With an annuity, you’d use your whole pension pot to “buy” a lifetime income, exhausting all your pension pot in one go. Pension Freedoms, however, gives you the option to mix and match the options that work best for you.
Each option has potential drawbacks if you don’t receive the right advice
The importance of budgeting with flexi-access drawdown
Flexi-access drawdown is a great option if you have income from elsewhere to cover regular expenses. This leaves drawn-down funds available for discretionary, one-off costs.
You need to be careful, though, that your withdrawals are sustainable. You’ll need to consider your life expectancy, potential later-life costs, and be sure that you budget accordingly.
You’ll also find that the state of the stock market at the point you withdraw will affect the number of units you need to sell, so keep a close eye on your remaining pot.
We can help, so contact us if you have any concerns about managing your pension withdrawals.
Taking some flexible options might mean you trigger the Money Purchase Annual Allowance (MPAA)
Your Annual Allowance is the amount you can contribute to the pension plans you hold while still receiving tax relief. For the 2021/22 tax year, it stands at £40,000 (or 100% of your pensionable earnings, if lower).
Some flexible options, though, will trigger the MPAA. This reduces your Annual Allowance from £40,000 to £4,000. This will severely limit the tax-efficient pension contributions you can make if you intend to keep contributing.
A lump sum could move you into a higher tax bracket and you could get emergency taxed
Your pension is taxed as income, which means that taking your whole fund as a single lump sum could push you into a higher tax bracket, increasing the Income Tax you pay.
You’ll also need to be aware that lump sums might be emergency taxed. This is because the lump sum you receive is taxed as though it is the first in a series of monthly payments, effectively dividing your Personal Allowance by 12.
The overpayment can be claimed back but you’ll need to be aware of this if you’ve earmarked the money for a time-sensitive purchase.
You can use the defined benefit (DB) plans you have to offset DC flexibility
If you have DB plans, you might be tempted to transfer out to a DC scheme to access Pension Freedoms, but this is rarely a good idea.
The pension offered by your DB schemes is likely superior to that you’d get with a DC scheme. There are added benefits that might apply too, such as a spouse’s pension or protected tax-free cash over the usual 25%.
Rather than transferring away from a DB scheme, use it to provide stability. The regular income might be perfect for paying recurring fixed expenses, such as household bills.
Your tax-free cash entitlement, or flexibility from DC plans, can then be used to cover one-off discretionary expenses, like holidays and other luxuries outside of day-to-day living.
Get in touch
If you would like to discuss your retirement options, and how best to balance flexibility with the difficulties of budgeting, please contact us today.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
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