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The finer details of Pension Freedom change constantly. As it currently stands, you can decide to take your whole pension out if you want to, but you will be subject to an Income Tax charge that is determined by your other earnings. For most people this won’t be a good idea, but let’s take a closer look at why.
The first 25% is tax-free, as before, but the remaining amount is taxed at your marginal rate. So if you had other income of £12,000 from sources like the State Pension, the first £33,000 you took out of your personal pension would be taxed at 20%, then 40% up to £100,000. It gets a bit more complicated after this, as you then start to lose your personal allowance: In effect, you pay a 60% tax between £100,000 and around £120,000, then 40% between £120,000 and £150,000, then 45% thereafter. Of course, these figures change over time depending on the banding and tax rate at the time, but the principles are likely to remain the same.
In other words, unless there is a really good reason you want your money out of the pension, it is not sensible to take all this money out of the pension in one go, depending on the value of course. You could, however, take a pension of around £500,000 out over five years and pay no more than 40% tax. This gives you a lot more flexibility and options, particularly if passing some of your funds down to the next generation is important to you. You could, for example, place this money into a Trust that, whilst paying you an income, is outside your estate for Inheritance Tax purposes, if that were a particular concern.
For most people, it will be better to take the pension income more gradually rather than grab the lot. Doing so will not only reduce the Income Tax, but will also do the same to the Inheritance Tax liability. If you take the money out of the pension minus 40% tax and then die, this money could be subject to another 40% Inheritance Tax. That means your children receive only 36% of what it was worth inside your pension. Had you left it there, they would have had 100% if you died before 75, and between 100% and 65% if it is after you are 75. Furthermore, whilst inside your pension it is growing tax free, it is likely to be taxed if it is growing outside the pension. Finally, once outside your pension, the money will be inside the ‘means test’ for long-term care fees, whereas inside the pension it may be better protected. Therefore, it’s not usually a good idea to take out all of your money, but it is great to have the flexibility you need. The best thing to do is to seek independent advice that can take into account your specific situation. One way of doing this is to visit us at www.efficientportfolio.co.uk or call us on +44 (0)1572 898 060. We would love to help.
The Annuity Evolution
After Pension Freedom, companies in the annuity market will have to innovate or face extinction, so expect some interesting developments in this space. Already some options have evolved for buying fixed-term annuities. For example, you could use a chunk of your retirement funds to buy an annuity that pays a set income for five years. This would allow you to leave the remaining funds to grow untouched for that period of time, at which point you could look to either purchase another annuity (fixed-term or for life) or use drawdown, depending on your need at the time. I predict that this area will evolve very quickly over the coming years to provide people with a happy compromise between drawdown and annuitisation.
As an annuity can be seen as an insurance on your income, combining an annuity with a drawdown strategy may be the best way to facilitate your income in retirement and add security to your future.
The Third Way
There have already been some interesting developments in this no-man’s-land between annuitisation and drawdown. These in-between products were referred to affectionately as ‘the third way’. We had seen a rise of companies that would offer the benefits of drawdown with the security of having a minimum guaranteed income. By 2008, some interesting products evolved that benefited lower-risk clients. Sadly, with the Credit Crunch, and specifically the fall of Lehman Brothers who underpinned a lot of the market’s guarantees, most of these products were pulled. Those that are left provide a very expensive guarantee that, for most people, isn’t worth paying. Going forward, I would expect this market to innovate again and become more buoyant, as we have seen in the US retirement market.
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