So, we’re now nearly six months into pension freedoms and things are starting to settle down a little. Members seem to be acting more prudently than initial predictions suggested, and elite sports car showrooms are not yet full of pensioners with their wheelbarrows of cash!
As the changes were announced around a year in advance, there was always expected to be a surge in activity following 6 April 2015 as many members who would otherwise have used their defined contribution (DC) pension fund to purchase an annuity during 2014/15, in light of the proposals, decided to wait until they were able to access the pension freedoms. The feedback from the pension providers seems to be that these were typically members with smaller pension funds.
Pension providers, in the main, are now able to offer DC pension scheme members access to their pension savings as they wish, although with certain restrictions on minimum withdrawals, frequency and potential additional charges and requirements for advice. It’s not quite like a ‘bank account’, but members certainly have more control over their pension savings than they did before April.
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For example, one client of ours is ‘retiring’ at 55 and has rethought the next phase of her life. In addition to her current DC scheme, she has an old DB scheme that kicks in at 62 and her State Pension at 66. The plan currently is to get more involved with her hobby and become a pilates teacher, so she will stop work, train for about a year and gradually build her business.
Her initial income requirements will be high as she will have to fund her training as well as all her normal living expenses. This first year is going to be funded from her tax free cash, in year two the income requirement will reduce slightly as her training costs will have finished and her pilates business will start to generate an income. Any income gap will be funded from a withdrawal of capital from her DC fund. This will continue as necessary until she reaches 62 when her DB pension starts, by that time her pilates income and DB pension should be sufficient but she will still have the flexibility to plug any gaps with her DC funds if necessary. At 66 her income will increase with her State Pension and this should allow her to preserve any remaining DC funds for her long term care needs.
A great deal of care has been taken to model her income requirements over time and build a cashflow projection to plan how the income will be funded and clearly this lady is fortunate to have her health and has built up sufficient funds. However, whatever life throws at her, she has the ability to be flexible with her income and adapt. This example can demonstrate how the new flexibilities can work really well around your plans, rather than you having to adjust your plans to suit the income you have available.
These pension freedoms do come with some pain, and one of the biggest ones is the increase in greater complexity, more individuals approaching retirement than ever now understand that they need to become more aware and an individual’s thirst for knowledge is growing. Pension Wise can help, as can the various retirement modellers that are available from the pension providers which can help to understand just how long your projected retirement fund will support the income you require, i.e. what age will you be when your money runs out, and do you therefore need to save a little extra now?
For those considering accessing their pension savings now, a couple of tips to avoid unexpected taxes and fines:
- Whilst it may seem attractive to access your pension fund as soon as you can after age 55, it should be remembered that only 25% is tax-free with the balance subject to income tax. So taking a large withdrawal in one year may incur significantly more tax than would be paid if this were spread over a number of years. Also, for those claiming means tested state benefits, these could be affected due to the increase in taxable income.
- Whilst it may seem attractive to encash an old DC pension to pay for the new kitchen or next year’s holiday whilst continuing contributions to your current employer’s scheme, don’t forget that you would then be subject to a £10,000 annual allowance which would restrict the amount that you can save into a pension thereafter.
- Importantly, you are required to inform any other pension schemes to which you are still contributing that you are subject to a reduced annual allowance and if you fail to do so within 91 days, HMRC will hit you with a fine of £300 increasing by £60 a day until this is rectified!
Finally, don’t forget that a 65 year old retiring today would be expected to live into their mid/late 80’s – so don’t spend it all at once if you’re planning to have a long and happy retirement!