Enjoy your ‘income’ gap year / update01 September 2016
It took a little while for the public to review the way that they can access their pensions, but the use of these funds has now accelerated. This was recorded recently by The Association of British Insurers (ABI) here:https://www.abi.org.uk/News/News-releases/2016/03/ABI-pension-freedom-statistics-one-year-on-factsheet
In addition, there have been recent warnings from the ABI on taking too much from your pension savings. The ABI reported this here:http://www.bbc.co.uk/news/business-37059950
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It is important to remember that the fundamental purpose of a pension fund is to provide you with income when you choose to retire, and in theory this should be managed so that it lasts you for the rest of your life. However, many people build up a range of pension benefits over their lifetime which could potentially be used at different stages during retirement to provide an overall ongoing income for life.
The new pensions freedoms that came into effect in April 2015 introduced far more flexibility to the ways in which pension benefits could be drawn. Before this point, significant restrictions applied to most pension pots in terms of how these savings could be accessed and the amount that could be drawn, either as a regular income or a one-off lump sum.
Following the momentous changes to pensions and retirement legislation in 2015, it is now possible to draw the entire value of your money purchase pension plan in one go, with 25% of this being tax-free under current rules, and the balance of 75% being liable to income tax. This facility has the potential to create some pretty scary tax bills if used incorrectly – however, with careful planning, the new freedoms can create real opportunities to tailor your retirement strategy in terms of when you retire, how your pension income is generated when you finally get there and how much tax you pay on it.
A good example of this is a situation we have seen several times recently, where an individual who has built up both final salary and money purchase pension plans wishes to retire early. The penalties for drawing on a final salary scheme before the scheme's normal retirement date are often severe and it is prudent to avoid these if possible. It is also important to bear in mind that when you draw benefits early, you are not only giving up a proportion of your annual benefit, you are also losing the index-linking on this proportion, which can mean that the 'gap' between the full income that would have been available and the actual income taken can widen over time.
One potential solution, dependent on your individual circumstances, is to create a 'gap year', where an individual leaves work and receives no earned income, using money purchase pension funds to bridge the gap between leaving work and drawing final salary benefits. This can also be a tax-efficient way of drawing benefits, taking lump sums from pension schemes either taxed at nil rate or taxed at basic rate and avoiding if possible the exposure to higher rate tax if large sums are drawn in one tax year.
Obviously not everyone is in the fortunate position of having final salary benefits to fall back on – however, many will have built up a range of pension pots over the years and it is important to identify the most efficient ways of drawing on these.
Overall retirement income may come from various sources, including investments and the State Pension, which has changed for those now eligible this tax year. We are advocates of getting this checked here: https://www.gov.uk/check-state-pension
Pensions and retirement are important topics and can be a complex area and if you would like to know more about the way that pension benefits can be drawn then please do not hesitate to contact the team at Chapters Financial at either our Guildford or Woking offices.
No individual pension / financial advice is provided during the course of this blog.
Keith Churchouse FPFS
Chartered Financial Planner
CFP Chartered FCSI
Chapters Financial Limited is authorised and regulated by the Financial Conduct Authority, number 402899.