Retirement income planning has been turned on its head. And the re-education of investors about where they should draw the bulk of their retirement income from in the new tax year has begun in earnest.
The key issue here is the true cost of stripping income from a pension and what alternative options are available. There’s never been a greater need for ongoing advice.
Withdrawals from an ISA are tax free, though potentially subject to IHT on death, but withdrawals from a pension can attract a rate of tax from zero to 60%. The skill is to ensure that as little tax is paid and as much of the pension fund is preserved, as possible.
It is worth reminding ourselves just how effective using pensions as a means of saving is. To take a simple example, a higher rate taxpayer saving a £100 net income a month over forty years, and based on a growth rate of 5% gross per annum, would have accrued just under £250,000 in their pension, compared to just under a £150,000 in a NISA.
So if the individual dies and has an estate that is liable to IHT, then after the 40% IHT tax charge there would be net assets of £90,000 from the ISA to pass on to the individual’s beneficiaries. As regards the pension fund, if the member dies before age 75 there will be a lump sum death benefit of £250,000 as a legacy. In the worst case scenario, where the member dies after reaching 75, with the uncrystallised fund paid as a lump sum being subject to the reduced special lump sum death benefit charge of 45%, this will leave net funds of £137,500 to gift on. That works out as between 53% and 178% more wealth to pass on compared to if the same net income had been invested into an ISA. According to the Office of Budgetary Responsibilities, currently 1 in 20 families will be caught by IHT, however, come 2018/19 it is predicted to rise to 1 in 10. This will have an ever increasing impact for individuals who are in retirement and stresses the need to ensure that the effect of all taxes must always be taken into account.
The new pension fund strategy will be to preserve as much of the pension fund as possible and look to all savings and assets as a source of income in retirement, maximising the tax reliefs and exemptions that are available over the traditional view that stripping income from a pension is best. Even if other savings become exhausted or there is a need for ad hoc payments, the member can dip into their pension fund as and when required.
There will be three winners out of these changes: advisers, platform providers and most importantly, members of a personal pension, but all will be reliant on breaking away from the traditional views of sourcing income in retirement.