One in ten people who plan to retire this year expect to withdraw their entire pension savings as one lump sum, according to research by Prudential.
Is that a bad thing?
It could be.
While everybody is free to make their own decisions about their money; withdrawing all your pension, or taking too much, too soon, could land you with a large and unexpected tax bill in the short term, as well as causing financial hardship in the future.
The research shows that 20% of those planning to retire in 2018 may pay unnecessary tax bills, while 10% plan to take their entire pension as a lump sum.
We are concerned that these people may be making mistakes with their pension, which, while not immediately obvious, may cause difficulties in the future.
We believe there are three key reasons why you should keep some or all of your money invested in pensions:
- Avoiding an unnecessary tax bill by taking more than you need: By taking a sustainable income, you minimise your tax liabilities and increase the chances of your pension providing an income for the rest of your life; and potentially that of your spouse. Taking more than you need could trigger an expensive tax bill which will see your money go to the taxman, rather than continuing to provide an income for you and your family.
- Pensions have benefits: By keeping your money invested in a pension, you can continue to benefit from:
- Tax-efficient growthMoney kept in a pension grows tax efficiently. By moving this money into a savings account, you remove the possibility of seeing much growth at all, as well as ensuring that any growth above this limit will mean that you lose some of those returns to the taxman, anyway.
- Death benefitsAny money remaining in your pension when you die can be passed on to your nominated beneficiaries and is usually free from Inheritance Tax. By comparison, money held in savings accounts forms part of your estate, and if the total value of your belongings is above £325,000 (or £650,000 if you are the remaining partner in your marriage and your spouse left everything to you) your beneficiaries will be charged IHT at a rate of 40% on anything over the threshold.
- Continued contributionsAs long as your pension remains active, you can continue making deposits into it. That means, if you choose to continue working on a part-time or consultancy basis while retired, you could continue to boost the value of your pension fund to either pay for care in later life or leave a bigger legacy for your loved ones when you die.
- Avoiding investment mistakes: There are two common investment mistakes made by those taking money out of their pension unnecessarily:
- Withdrawing money to put into a savings account: This has several potential downfalls. First, you could incur a large tax bill if you take out more than the 25% tax-free lump sum. Second, by putting that money into a normal savings account, you almost guarantee that it will lose value in real terms, as interest rates are currently below inflation and that doesn’t seem likely to improve anytime soon.
- Withdrawing money to invest in property: Lots of people believe that property is a sure-fire winner and that all property investments will generate huge returns. In fact, there is no guarantee of that. The only thing you can be sure of when doing this, is that you will trigger a tax bill when withdrawing the money, to then invest in a single asset class; which is also taxable.
What is that money being used for?
Of those who are making big withdrawals from their pension pots within the first year of retirement, 71% are likely to invest in property, put it into a savings account or invest it. The other 29% are looking to spend the cash, with:
- 34% using it to go on holiday
- 25% planning home improvements
- 20% giving financial gifts to children or grandchildren
Of course, there’s nothing wrong with treating yourself and those you love when possible, but, by taking more than the 25% tax-free limit, you put yourself at risk of using more money than planned and leaving yourself short in the long term.
What can you do with your pension fund?
When accessing your pension, you can now use some or all of it to:
- Buy an annual guaranteed income, such as an Annuity
- Create a Flexi-Access drawdown arrangement, which lets you make withdrawals as and when you please
Any money you don’t convert into retirement income this way can either remain invested in your pension, or you can withdraw it and put it into a savings account.
We’d suggest leaving it where it is.
What happens to pension funds which are put into savings accounts?
Taking that money out of investments and putting it into a Cash account will do two things:
- Remove any possibility of growth beyond the bank or building society’s interest rate. This is likely to be below inflation and will mean that your money loses value in real terms
- Make you more likely to incur tax bills if you use the money at a later date.
Retirement planning is a big part of your overall financial plan. It needs to include provisions to support your desired lifestyle when you leave working life behind, as well as containing any strategies you will use to make sure that you can leave some money or assets behind for loved ones.
Therefore, your retirement plan should involve the most useful and productive strategies to meet your aspirations and goals for both you and your family.
For more information, or to begin planning your retirement, please get in touch with us.
