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13 November 2014

Ian Price, Divisional Director, St. James’s Place, cautions against overlooking the tax implications of next year’s improved pension flexibility.

“200,000 will blow pensions next year”

This was just one of several headlines taken from coverage of early detailed research into the possible impact of pension liberalisation – specifically what individuals are going to do with their pension fund after 6 April next year. After this date, those aged 55 and over will be able to take their entire pension as a lump sum. But, as always in not looking beyond the headline, there is a risk of missing the detail.

In this case, it is the detail of the new legislation – such as how income from that pension pot will be taxed. Taking the whole fund at once might be the right thing to do for a few people; but before making any decision everyone needs to understand the options available.

Let’s assume you have a fund of £100,000 when you come to take your benefits. The great news is that 25% of your fund – £25,000 in this example – can be taken tax-free. This leaves £75,000. If you take this as one lump sum it will be treated as income in the year that you take it. When added to your other sources of income in that year it’s highly likely you would pay higher rate Income Tax on a large proportion of it. I suspect that people’s enthusiasm for cashing in their entire pension may dampen once they discover that 40% of their hard-earned money will go to the Treasury. I have a feeling most people who take advantage of the new flexibility will ultimately draw their pension at a rate that is more tax-efficient.

Complex choices

There’s no question that the new rules being introduced by the government in April will give everybody more choice about how they plan for retirement. But with this increased flexibility comes greater complexity. The new pension legislation presents a number of tax-planning opportunities when you get to retirement; but if you’re not careful, without advice, you could end up making the wrong decision.

The first thing to do is to go back to basics. By this I mean you need to decide when you want to retire and, more importantly, establish how much money you’re going to need to live off. In some ways this is the $64,000 question, but without knowing this it’s impossible to make the right decision about how you’re going to take the income from your pension fund.

Facing reality

But, worryingly, the focus on the new flexibility of pension benefits overlooks the fundamental issue that people are not saving enough for retirement and not putting a sufficient fund in place. We all hope to have a long and happy retirement, but to do so we need to make sure that our money lasts as long as we do. The good news is, on average, we are all living longer than ever before; it is going to be quite possible for the majority of us to spend at least 20 years of our lives in retirement.

The less good news is that the average pension pot at retirement is just £36,800 (source: Association of British Insurers – September 2014). How benefits are taken from a fund of that size is far from the biggest problem.

In reality, more and more of us are going to have to work longer because we haven’t saved enough. The key is making sure that during our working lives we are putting away enough money so that when we do finally get to retirement, we can make the right decisions based on the comfort of knowing we have sufficient money to enjoy our later years.

Retirement planning is all about making sure that when you are working you are putting enough money away for when you stop. The pay days you have until you retire are the number of opportunities you have to build the fund needed to create the lifestyle you’re hoping for. 

The levels and bases of taxation and reliefs from taxation can change at any time and are generally dependant on individual circumstances.

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