Introduced in April 2015 the pension changes brought freedom and choice on how to take income in retirement. It means that most people, age 55 or over, can now withdraw as much or little income, as and when they like from their defined contribution (DC) pension scheme.
It may be tempting to take advantage of the new freedoms and cash in your pension, but have you really thought through what’s involved?
Financial education in the workplace provider WEALTH at work shares its top tips to help you make an informed decision.
1. Don’t pay unnecessary tax
Tax planning should be at the heart of any pension transaction you undertake. Don’t forget that only the first 25% of the amount that you drawdown from your pension pot is tax free and the remaining 75% is taxed as earned income. If you cash in a pension during a tax year when you are still working, 75% of the sum withdrawn will be added to your earnings for that tax year and may push you into a higher tax bracket. It may therefore be worth considering withdrawing smaller amounts from your pot.
For example, if you're a non-taxpayer and have your full personal tax allowance available (£11,500 for 2017/18), you could withdraw £15,333 tax-free – 25% as tax free cash (£3,833.33) and the remaining 75% (£11,500.00) would fall within your personal allowance.
An option could be to take an income through ‘partial’ or ‘phased’ income drawdown. This would enable you to drawdown small amounts of your pension pot while keeping the majority of your savings invested in the pension and growing tax free. Of course, growth isn’t guaranteed and the value of your pension could fall instead.
Another important point to note is that if you withdraw any cash simply to add to your savings, the money withdrawn will form part of your estate for inheritance tax purposes. If left in the pension scheme, it would be exempt of inheritance tax.
Ultimately, it’s crucial not to forget that a pension remains one of the most tax-efficient saving vehicles available.
2. Will your retirement savings withstand the test of time?
Before taking the cash, it is crucial to think about if you will have enough money to last the duration of your retirement. For example, a 65-year old man now has a 50% chance of living to 87 and a woman of the same age has the same chance of living until she’s 90, so making your retirement savings last is key. But don’t forget, it’s not a one-off decision; it’s advisable to regularly review your choices throughout your retirement as your needs evolve and income needs may change.
For example, income requirements are widely believed to follow a ‘u shape’ in retirement with the first ‘active’ phase being the most expensive. Spending seems to fall after a while in what is known as the ‘passive’ phase, as people become a little less active and perhaps cut back on areas such as travelling. But costs then may go up later in retirement in the ‘supported’ phase, if extra care and support is required.
3. Does your pension scheme allow it?
If you’re convinced that cashing in your pension pot is the right move for you, you need to ensure that your pension scheme allows you to do so.
You may, for example, be a member of a final salary, or ‘defined benefit’ (DB) scheme, which currently prohibits members from taking their savings in one go (unless on the grounds of serious ill health).
This means that you’ll need to transfer your savings into a suitable pension scheme to be able to access your cash. However, pension transfers are complex – there are many things you should consider before making any decisions, including if the transfer value being offered represents good value. Transferring from a DB pension scheme can mean that you will be giving up valuable guaranteed benefits and you might find yourself worse off.
To protect consumers it is now a legal requirement to take regulated financial advice for transfers on DB schemes valued at £30,000 or more. This advice is a highly specialised area and only certain advisers hold the relevant qualifications and permissions to help you. It should also be noted that the Financial Conduct Authority’s (FCA) current view is that a transfer will not be suitable unless it can be proved to be in your best interests.
4. Beware of scams
Pension savers getting scammed out of their retirement savings is a real issue. The problem is many of these scams look perfectly legitimate so are not easy to spot. Others offer investment returns which are too good to be true but people easily get sucked in. They often have very professional looking websites and literature.
Whatever you are planning to do with your retirement savings, check before you do anything that the company is registered with the FCA. You can also visit the FCA’s ScamSmart website which includes a warning list of companies operating without authorisation or running scams.
5. Financial advice can be better value than no advice
Many people are concerned about the cost of advice without realising that when you buy retirement products such as annuities, through for example online brokers, there are charges deducted which can cost just as much, if not more, than getting advice.
A financial adviser should look at your personal circumstances, objectives and attitude to risk and then, after considering all of the retirement income options available, make a specific recommendation to address your needs; then you have the benefit of consumer protection for the advice given. After all, according to research by Unbiased, savers who take advice save on average £98 more every month and receive an additional income of £3,654 every year of their retirement, based upon a pension pot of £100,000.