5 months ago • 7 mins
Advice on how to draw on lifetime savings is top of the list for those who have just turned 55 and can access their pension savings for the first time.
Research by abrdn reveals that looking to the next five years, nearly half of individuals aged between 56 and 65 will most value advice on how to use their savings in retirement effectively, while maintaining enough for the rest of their lives.
The introduction of pension freedoms has enabled savers to realise their chosen lifestyles post 55 by allowing them to dip in and out of their pensions when needed. But to do this in a tax efficient way in conjunction with other wealth requires careful advice.
This was recently recognised by the Economic secretary to the Treasury, John Glen, who told the Work and Pensions Committee: "I think has been a success. The principle is just people having freedom to access money they have saved. It's just then about how you augment that with the right advice and guidance."
Having the right investment strategy combined with ensuring that the level of withdrawals remain sustainable are critical elements of any client's retirement plans. But it is also vitally important that those withdrawals are as tax efficient as possible.
If clients are solely reliant on pension savings in retirement, ensuring that they use their personal allowance is key to ensuring funds last as long as possible.
With the personal allowance currently at £12,570, this allows a client to crystallise £16,760 each year without paying any tax.
A greater tax free amount could be achieved by crystallising more savings and just taking tax free cash, but this could mean that more may be taxable in later years once tax free cash has been fully used. However, supporting income needs in early years just from tax free cash would mean that valuable personal allowances could be lost.
Alternatively, where a higher income is needed and to spread tax free cash over more years, the full crystallised amount could be taken each year.
For example, to avoid paying any higher rate tax, £67,026 could be crystallised. This would be made up of tax free cash of £16,756, and income equal to the higher rate threshold of £50,270. After income tax, this would amount to a net income of £59,486. The effective rate of tax on this net income would be just 11.25%, which is good value considering that the amounts saved could have been boosted by 40% tax relief. (Figures based on UK tax rates and bands, excluding Scotland).
Clients should also remember to factor in to their plans the State Pension when they reach State Pension age. This may mean they alter the amounts they draw from pension savings.
Some people may not want to fully retire, but instead reduce the hours they work, or even take up a new occupation or enterprise doing something that has been a long held ambition. This becomes more of a possibility from age 55 if they can support their part-time earnings by accessing their pension.
To do this tax efficiently, the same considerations as above apply with regards to using the personal allowance. Only this time there may be little or no personal allowance left if income from their occupation exceeds £12,570.
The choice is then whether to take tax free cash only, or a mix of tax free cash and income. Again, taking tax free cash only could mean more tax on the income element retained in future years.
However, there is an argument for taking tax free cash only. When a client draws taxable income from their drawdown pot for the first time, this will impose the money purchase annual allowance for the rest of their lives. This means that the total of future employer and employee contributions to money purchase pension schemes is limited to £4,000 a year. Anything over this will be subject to the annual allowance tax charge.
This could restrict future planning opportunities via pension savings and clients could even lose out on employer contributions.
When clients have savings in several tax wrappers in addition to their pension (such as bonds, OEICs, ISAs) this brings into play other allowances which can contribute to a tax efficient income. As well as the personal allowance, these include:
Juggling with these to get the best outcome for clients is probably where advice is most valued.
The level of tax free withdrawals available to a client with savings in pensions, ISAs, OEICs and bonds could be significantly more than the sum of the available allowances.
For example, let's assume a client has all of the above tax wrappers, and their bonds and OEIC portfolios are showing gains of 20%. Income required could be taken as follows:
This is just one of many ways that net spendable income could be produced from a client's savings. Note also that taking money in this way has retained the full personal allowance and PSA by keeping total income subject to tax below the higher rate threshold.
Should extra income be required, the client could still access this from their ISA, or as tax free cash from their pension if available, without incurring any more tax.
Alternatively, they could take more gains from offshore bonds to use up the personal allowance instead of drawing a pension income. This way, more of their savings can be left in their pension to grow tax free.
Taking gains from any onshore bonds is also an option, and provided the gain when added to other taxable income does not exceed the higher rate tax threshold, this may be achieved without any tax consequences.
So far we have looked at potential ways of producing a tax efficient income in retirement that lasts through retirement. The guiding principle is to make the most of all the allowances and tax breaks available.
But there are other factors at play which may influence how people fund their retirement. These include:
Our research indicates that in the first 10 years after reaching normal retirement age, advice on taking an efficient income and helping to make savings last throughout retirement is of most value.
Tax efficiency is at the centre of this, and while there is no one formula to fit all circumstances, fundamentally it is about making the most of the tax allowances and bands available, with a thought towards ultimately maximising total wealth transfer.
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.