January 18th, 2023
At-retirement decisions cost £1.7 billion a year. Here’s how a planner can help you to reach your retirement goals
If you are on the runway to retirement, you could be beginning to think about how you will draw a later-life income.
As you stop working and move into this new phase of your life, your financial circumstances will look different – and it’s important to be prepared for the change.
This income will likely come from a combination of the new State Pension, your private pension pot, and other savings and investments you have accumulated.
When it comes to your pension pot, assessing your funds and deciding both when and how you will take them is an essential step to take ahead of time. If you wait until you have already retired, you could rush into taking your pension and even lose an unnecessary sum to tax by doing so.
Indeed, an HSBC study, published by Money Marketing, has confirmed that UK pensioners lose almost £2 billion a year due to the “costly pathways they take to access their money”.
So, if you are on the cusp of retirement, it’s time to start researching these all-important decisions – and we can help.
Read on to find out why now is the time to act on your retirement goals.
Seeking guidance before retirement can help you make tax-efficient decisions
One crucial financial decision you need to make when planning your retirement is how you will draw your pension.
If you are part of a defined benefit (DB) scheme, your pension is normally provided by either your employer as a final salary pension or as an annuity you have purchased.
Alternatively, with a defined contribution (DC) pension, likely to be a modern workplace scheme or your personal pension pot, you can choose how to draw the money yourself.
Since the Pension Freedoms reforms implemented in 2015, when you reach the age of 55 (rising to age 57 in 2028), you can usually draw funds from your private pension pot.
There are multiple options to choose from when taking your hard-earned funds from your pension, and some are more tax-efficient than others.
Here are two drawdown methods and how they could affect your tax burden in retirement.
- Taking your entire pension as a lump sum
When the day of your retirement finally arrives, you may feel it is easier to draw your entire pension in one go. A lump sum payment means you have full control over your pension savings from day one, and can use it as you wish. You can reinvest in your pension when you choose.
However, taking your entire pension as a lump sum can have negative ramifications when it comes to tax.
Usually, you can draw up to 25% of your pension as a tax-free lump sum. If you draw it all at once, the remaining 75% will generally be taxed at your marginal rate. This could easily push you into a higher tax band when added to your other income, meaning you could pay up to 45% Income Tax on your pension when you use this drawdown method.
- Flexi-access drawdown
Flexi-access, as its name suggests, allows you to draw money from your pension only when you need it.
You can take tax-free cash, up to the 25% limit, whenever you like throughout retirement. Flexi-access allows for a more varied lifestyle; for example, you may decide to spend more on an amazing travel experience one year, and then live more frugally the year after that.
While helpful for those wanting to access funds when they wish, flexibly accessing your pension triggers the Money Purchase Annual Allowance (MPAA). The MPAA reduces your Annual Allowance (usually £40,000 or your total earnings, whichever is lower) to £4,000 a year – meaning there is a stricter limit to how much you can continue to invest in your pension once you retire.
Overall, it could be that flexi-access is a more tax-efficient method of taking your pension – although, of course, your circumstances are unique, and discussing the tax implications of your situation with a professional may be beneficial.
Creating a retirement plan with an expert can help you prepare for the transition
According to the Money Marketing report, the latest FCA data confirms that of the most recent 705,666 pensions accessed, 56% of those were drawn as a single lump sum.
What’s more, according to a Just Group press release, more than half (53%) of the DC pension pots accessed for the first time in 2021/22 were taken by “DIY dippers”, meaning those who did so without regulated advice, or using the government’s free, impartial and independent guidance service Pension Wise.
The benefits of working with a financial planner to create a retirement plan can be far-reaching. We can help you:
- Calculate a tax-efficient method of taking your pension
- Work out how much you could take as later-life income using cashflow modelling software. This can ensure you make sustainable withdrawals, which means you are unlikely to run out of money in later life
- Plan for large, one-off costs in retirement, such as taking a bucket-list world tour, or helping the next generation buy a home
- Prepare for later-life care costs – a 2022 government report claims 3 in 4 people will need later-life care at some point
- Factor your pension and other retirement income into your will
- Prioritise your goals, both financial and personal, as you head into this next phase of your life.
Taking this planning stage seriously in the years leading up to retirement could help you avoid costly at-retirement decisions while making the most of the final years of your career.
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After your life of hard work, you deserve to stride into retirement with confidence.
This article is no substitute for financial advice and should not be treated as such. To determine the best course of action for your individual circumstances, please contact us.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
Workplace pensions are regulated by The Pension Regulator.