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How To Live Your Best Retirement With The Power Of Flexible Access Pensions

How To Live Your Best Retirement With The Power Of Flexible Access Pensions

By Alex Pritchard

 

How would you like to only pay £500 of tax per year on your pensions? Sounds good right? Well, read on to find out exactly how it works. You can also listen to our latest episode of A Dab Of Investment for advice on this handy little tip.

The rules and regulations around tax and pensions are often confusing – it can be hard to understand precisely what is going on. Too often, people end up losing money unnecessarily to taxation which might have otherwise been avoided. Fortunately, the relatively recent introduction of flexible access pensions, in combination with strong financial advice, can help see you through.

What are flexible access pensions?

Back in 2006, the government implemented several pension simplification policies. From that point, a UK pension could be considered a pot of money that had your name on it, to be used in whatever way you chose. Some misspent it, withdrawing hundreds of thousands of pounds and losing around half to taxes – a tidy profit to the government perhaps!

However, more people used this freedom reasonably and sensibly, engaging independent financial advisers to help them make sure that this money was put to best use. This led to a massive shake-up to how everyone interacted with their pensions. Annuities became far less popular for example – they only paid out a small percentage of what you had paid in, and when you died, whatever was left was lost.

In response to this shift, the government implemented flexible access pensions in April 2015. This new system of pension lets you, with the support of a financial adviser, choose how much you want to take out per year, while still maintaining the size of the fund. On top of that, when you die, you can then leave something to pass on to your loved ones

What might this look like in action?

Imagine your pension was £200,000. A reasonable amount of money to withdraw per year, while maintaining the size of the fund, would be perhaps £8,000–£9,000. Anything you withdraw for yourself is subject to income tax for that year, so you would need to be careful about withdrawing amounts that might push you into a high tax bracket.

Then, when you die, you would be able to leave whatever is left in the pot to your heirs. If the pension’s value, including your withdrawals, was less than a million pounds and you were under 75, then this is entirely tax free – no income tax and inheritance tax! If you were over 75, it is still inheritance-tax free, but your heirs would need to pay income tax on withdrawals, in the same way that you would have needed to pay income tax.

What to be aware of

The main catch to be aware of here is that flexible access is only offered by modern pensions (pension schemes from after April 2015). Older pensions do not need to offer this flexibility to you. Therefore, it is a sensible idea to seek financial advice as to whether your pension qualifies, and to help you move over if needed.

Maximising the value of your pension

Everyone knows that you can simply withdraw 25% of your pension tax free. However, unless you are paying off a mortgage or debts with it, withdrawing it might not be the best decision. 

In your pension fund, the money is inheritance-tax free – removing it from your pension fund and adding it to your estate as a potentially six-figure lump sum might mean your estate has to pay 40% inheritance tax on it! Why pay more tax than you have to?

A sensible alternative is to use tax-efficient drawdowns to supplement your monthly income. This allows you to maximise your income while minimising your tax payments.

For example: 

You have a fund worth £500k.

You want to withdraw £20,000 a year as income to live off – a reasonable amount to sustainably live off from a fund this size.

25% of this – i.e. £5,000 – is tax free with tax-efficient drawdown.

£15,000 left over is taxable income. The government gives you roughly £12,500 as a personal tax-free allowance.

This means that of £20,000 a year, only £2,500 is taxable. At a 20% tax rate, that’s only £500 payable to the government! 

In other words, using tax-efficient drawdown means that you get to keep £19,500 out of £20,000 withdrawn.

This 25% drawdown allowance scales up rapidly. If you were to be fortunate enough to have a pension fund of one and a half million pounds – something less uncommon as time goes by – a reasonable withdrawal might be £60,000 a year. With tax-efficient drawdown, you would get around £53,000 net back in your pocket.

Building your pension

Using tax-efficient drawdown is absolutely the most efficient way to have any sort of income during retirement. Here at Applewood Independent, we love it – it’s so easy to use.

It is also so easy to put money into your pension now – especially if you are a higher-rate tax payer. Putting £10,000 into a pension gets grossed up to £12,500 – then you get £2,500 back from the government for doing so. In the end, a £12,500 contribution only cost you £7,500!

Between this, potential for investment growth, and how little tax you need to pay, it is a very attractive pension to not only retire on but also to pass on inheritance-tax free. If you have an interest in using your pension funds efficiently, or you are not sure if you are on an old pension which does not provide the same benefits, check with your financial adviser today. 

There are many more benefits to flexible access pensions besides just these – too many to list here. For some more details, feel free to check out our new podcast A Dab Of Investment

However, when taking financial advice, it is always a good idea to consult directly with an independent financial adviser. Together you will be able to get to the bottom of what is right for you specifically. 

If you’d welcome our input, expertise and experience, please get in touch by emailing me at alex@applewoodindependent.co.uk

The views expressed in this article are those of the author and do not constitute financial advice. Applewood Independent Ltd is authorised and regulated by the Financial Conduct Authority. For financial advice designed for you and your specific circumstances, please contact the author using the contact details provided in this article or, alternatively, contact the Applewood Independent Ltd office on 01270 626555.

The value of your investment can go down as well as up, and you may not get back the full amount invested.

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