Savers drawing a pension income they don’t yet need are in danger of leaving a hole in their finances when they eventually hit retirement, writes Stephen Palmer.
Stephen, director of Uckfield-based Cranwell Wealth Solutions, says new research suggests that people are taking money from their pension long before they really need it, putting them at risk of depleting their savings before they retire.
Half of those who are already taking withdrawals from their pension are yet to retire. More than half of these full-time workers admit that they could live comfortably without the extra income, as do nearly a third of those in part-time employment.
Many pensions allow you to start taking benefits from the age of 55. This is one of the most popular features of the pensions system, as the money can be used to supplement earnings, pay for home improvements or even fund a long-hoped-for holiday.
But savers should think carefully before accessing their funds while they are still working, as they could trigger a host of unintended consequences. Drawing an income from your pension pot beyond taking the 25% tax free cash, for example, could push you into a higher tax bracket.
Another drawback of accessing a pension is that it can limit future contributions into the fund. Under ‘money purchase annual allowance’ rules, anyone dipping into their pension may see their saving allowance reduced from the usual £40,000 annual limit to just £4,000 a year. This is something to be aware of if you are planning to pay more into your pension in the future.
While it may seem tempting to dip into your pension early, it’s probably better to leave the money where it is. As long as money is held in a pension, it is shielded from Income Tax, Capital Gains and Inheritance Tax (IHT). Taking it out bursts this protective bubble.
Leaving the pension untouched also means that the investments can potentially benefit from more years of compounding returns. An extra 10 or 20 years of tax-efficient growth could make a big difference to the amount of income available to you or your family in the future.
Nowadays, retirees are often advised to use their ISAs first and their pension last. By doing so they can ensure that their pension, which is generally the most tax-efficient way of saving, is shielded from HMRC for as long as possible. Keeping the pension invested also means a greater value can potentially pass to loved ones in a highly tax-efficient manner.
If you can’t avoid having to dip into your pension pot, a good way to minimise tax is to phase withdrawals by combining small amounts of tax-free cash and taxable withdrawals to meet the need for income or capital.
If you need to plug an income gap, pay off a debt, or give children a helping hand, then it’s worth talking to your financial adviser who can recommend the most tax-efficient course of action.
St James’s Place
Through Cranwell Wealth Solutions the value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and the value may fall as well as rise. You may get back less than the amount invested.
The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances.