The Government has revealed it expects 130,000 each year to take advantage of the new ‘Pension Flexibility’ rules and raid their pension pot.
At the same time they also have shown how much the Government’s coffers will also benefit. According to new figures the new measures will raise £4 billion in additional tax receipts over the next five years.
The new rules have been broadly welcomed by most people. But if you are one of the 600,000 people planning to raid your pension we’d suggest there are many reasons why you should think carefully, here are seven.
#1: Unnecessary income tax bills
You will still be able to take 25% of your pension pot as a lump sum; any additional amounts though will be taxed.
We’ve already heard of people misunderstanding the new rules. Mistakenly believing that as they currently pay tax at a rate of 20%, any amount they take above the tax-free lump sum will also be taxed at 20%.
Wrong!
The money taken from the pension is taxed as if it were income. If your own personal income, plus the money taken from your pension, takes you over the higher rate tax threshold, £41,865 in the current tax-year, you will start paying 40% tax. Those people taking very large lump sums could pay 45% tax.
We’re concerned that many people will take money out of their pension in the mistaken belief they will only pay 20% tax on it, or even worse, thinking it’s all tax-free.
#2: It isn’t a piggy bank, it pays your bills when you stop work!
We know pensions don’t have a great reputation. But before you throw the baby out with the bath water and raid your pot, just because the new rules allow you to, think about why you took out the pension in the first place.
For most people paying into a pension is a tax-efficient way providing an income in retirement, if you’re luck your employer will pay in too.
If that’s the case, and assuming you can’t live on the State Pension alone, around £7,500 per year from 2016, why do you suddenly want to take all the cash out?
If you need your pension pot to produce an income, for most people the right thing to do won’t be to take large lump sums, but drip the money out so that the pot doesn’t die before you do.
Potentially boring, but very sensible!
#3: More tax for the Government, less cash for your dependents when you die
Let’s imagine that you ignore the first two points we’ve made and you raid your pension pot. If you subsequently die, all you’ve probably done is line the Government’s pockets at the expense of your family.
Here’s why…
We’ve already established that you’ll pay tax at a rate of 20%, 40% or even 45% on most of the money you take out of your pension.
But then when you die, there could be a further 40% Inheritance Tax to pay, depending of course on your own personal set of circumstances.
Contrast this with the pension, where there is no tax if you die before 75 and you’ve structured any withdrawals carefully.
There might well be very good reasons for taking money from your pension. But if all you’re going to do is hold onto the money, you could pay tax twice, when there’s no need to pay it at all.
#4: It’s an expensive way to repay debt
Most people would rather have no debt when they retire. But for many people, often because of the interest-only mortgage problem, this is hard to achieve.
It’s only natural therefore to see the new pension freedoms as a solution to a debt problem; but it could be very expensive.
Let’s say you earn £25,000 from your job in the year you retire, have a £50,000 interest only mortgage and £100,000 in your pension pot.
You can have £25,000 as a tax free lump sum, so that will clear half of your mortgage. But to repay the other £25,000 you’ve got to release a gross amount, before tax, of £36,045.
Therefore to repay £50,000 of debt, you’ll also have to pay £11,045 in extra income tax.
That’s a very expensive way to repay debt and it’ll reduce your retirement income too. Before taking money from your pension, we’d suggest you take advice and look at other options.
#5: ISAs as a pension alternative doesn’t work
We’ve heard people say they’ll take money out of their pensions to invest in ISAs (Individual Savings Accounts).
We can see why this is being considered, by some people, after all the ‘Pension Flexibility’ proposals were in the same Budget that pushed up the maximum ISA contribution to £15,000 each year.
But the idea of taking money from a pension to put it in an ISA is flawed, in fact it makes us want to tear our hair out.
Why?
- We’ve already shown that you will pay tax on the money you take from your pension
- A pension is already very tax-efficient
- They can both invest in the same places; in fact a pension can offer even more investment options than an ISA
- Any money you have in a pension will be paid out tax-free should you die before 75 and you’ve not taken any benefits; your ISA could be caught by Inheritance Tax
To put it simply, why generate a tax bill to move money from one tax-efficient pot to another?
There’s probably no reason to do it!
#6: Neither does buy to let
We’ve also heard people say that they will take the money out of their pension to invest in a buy to let property; again we believe this is flawed.
We should make it clear we’ve got nothing against buy to let investing as part of a diversified portfolio. But, factor in the tax you will pay on the money taken from your pension, the recent surge in property prices and the fact buy to let yields are lower than Annuity rates we don’t think it generally makes sense.
If you want to find out more, click here to take a look at our recent blog: Thinking of using your pension to invest in buy to let? Read on and think again
#7: A field day for financial conmen?
We’re nervous that the new pension flexibility will provide a new opportunity for financial conmen.
As we’ve said before pensions don’t have a great reputation. It’s therefore possible that unsuspecting pensioners could be duped into taking money out of their pension to put into other investments. These are often marketed as producing high guaranteed returns, when in reality they do nothing of the sort and are most likely unregulated making it impossible to get compensation if it all goes wrong.
If you get approached by anyone offering an investment which sounds too good to be true, then it probably is. We’d suggest you walk away and take advice from an adviser regulated here in the UK by the Financial Conduct Authority (FCA).
Confused about the best thing to do? We’re here to help
The new ‘Pension Flexibility’ will undoubtedly help many people. But just because you can take all your money at once, doesn’t mean you should.
There is of course the added problem that with more options comes greater confusion and a higher chance of making a mistake. Which is where we come in.
All of our advisers are retirement specialists; we understand the new rules and can help you make the best choice for your circumstances.
If you’re retiring soon get in touch with one of our team today on 0115 933 8433 or email info@investmentsense.co.uk
