Balancing retirement income and wealth legacy options
9 October 2018
Peter Hopkins, technical director at AJ Bell, looks at the practical issues with which retirees now have to contend and the options they have when it comes to balancing the taking of income and leaving wealth to their beneficiaries.
Since 2015, the temptation for some people to plunder their pension savings has become greater, especially when over 55 and the pension is not an unfunded, public sector pension one, since it is now possible to ask the administrator to pay it out all at once.
That’s either good or bad depending on your view on issues like longevity, the level of thrift in the population, the ethics of bailing out spendthrifts, whether or not you think people can be trusted, whether or not people want to spend their retirement managing an investment portfolio.
But let’s leave that behind and look at the position someone might find themselves in at the point they want to start consuming retirement savings rather than accumulating them.
Such a potential retiree may have a DC pot, a small DB pension, an ISA and a few shares. Each of these is taxed in different ways and that opens up the opportunity to extract value that is either cognisant of tax or potentially expensive.
This is because in any tax year the retiree will have: (a) an ISA subscription; (b) a personal allowance; (c) until 75 the ability to put money into a pension; (d) a capital gains allowance; (e) the basic rate band.
The temptation is to do everything at once. Cash everything up and pay the tax.
Let’s look at that DC pension. There’s £200,000 in it. £50,000 tax free and just take the rest out? £150,000 withdrawal in one hit will be taxed at a hefty £53,100. Taking out a payment of £46,350 for three years and a final one of £10,950 and the tax is, at current rates and no indexing, £20,700. Take it out over thirteen years, however, and there’s no tax at all.
This needs to be borne in mind. Whilst it might be good to keep the DC pension untouched for inheritance, don’t forget about the ‘unexpected event’ which may require a lump sum. If drawing from the DC pension takes the income for a year over a tax threshold you will pay more tax on that withdrawal. So if there isn’t an immediate source of funds other than the pension, it might be worth taking pension income if it’s taxed at the usual marginal rate of the taxpayer.
When the state pension kicks in, that and the DB pension will probably use up the personal allowance. At that point, you may want to take income from savings and ISAs that will potentially be subject to IHT as opposed to the pension which won’t.
Then, as 75 approaches, the client needs to consider whether there’s any wealth that they definitely want to leave as a legacy and get that into the pension.
Our late colleague Mike Morrison used to tell the story of a taxi journey he once took. The cabbie said that he’d just found that he had a £55,000 pension he’d forgotten about. Mike asked him what he was going to do and the cabbie said, “I’m going to draw it all out tomorrow and spend it on a holiday.”
Mike thought and told him to take half out tomorrow and half in a week’s time, after the start of the next tax year. A real example of the problem here – annual tax allowances and the freedom to take as much or as little as you like.
It will all depend on circumstances, but the old, paternalistic ways are gone. No longer is it a pension for life from a DB scheme or an annuity. It’s a rollercoaster ride through the excitement of retirement.
People retiring in future will need support not only in investment management, but life expectancy risk understanding, tax planning and maybe even having a good time.
If there was ever a time for people to recognise the value of advice, it is now.
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