Pension Freedoms legislation arrived in 2015 and was recently hailed as a success by the Treasury. It allowed retirees to access their funds in more flexible ways than ever before, but it has hidden drawbacks too.
While the anticipated rush to withdraw entire pots in one-off lump sums from the age of 55 didn’t occur, millions have fallen foul of other pension tax traps.
The Times reports that since 2015 nearly ÂŁ750 million has been overpaid in emergency tax by retired people dipping into their pensions.
Meanwhile, according to a report by the Just Group, and published by Actuarial Post, more than 1,000 pensioners every working day are accidentally triggering the Money Purchase Annual Allowance (MPAA), thereby severely limiting their tax-efficient pension contributions in the future.
The decisions you make at retirement can have far-reaching consequences and a huge impact on the type of lifestyle you can afford to live.
Here are three ways that seeking professional financial advice can make a significant difference.
1. Sticking to your plan
Once you have a retirement plan in place, you’ll probably find you have greater confidence in your future and a sense of financial control. We can help you to ignore external noise and stick to this plan.
But that doesn’t mean it has to be set in stone. Life events – births, deaths, marriages – might alter your priorities. Your idea of a “dream retirement” could also simply change as you get older.
At HDA, we can help you revisit your plan if it no longer aligns with your wishes or values.
2. Remembering that retiring earlier means budgeting for longer
One of the main issues when retiring earlier than planned is that your money will need to last that much longer.
The Office for National Statistics (ONS) confirms that the average UK man can expect to live to around age 79 and a woman can expect to reach age 83.
Retiring at 55 could mean your pension pot has to last another 30 or even 40 years. That makes budgeting exceedingly difficult, whichever option you choose.
If you take a lump sum, you’ll need to think about where you keep the money. The UK’s current low interest, high inflation economy means that any retirement funds you hold in cash are likely to be effectively losing value in real terms.
Opting for flexi-access drawdown means you’ll have to ensure your withdrawals are sustainable and that your fund will last you for the rest of your life.
Recent pension figures from the FCA confirm that 43% of those who took drawdown during the 2020/21 tax year withdrew at a rate of 8% or above. The FCA called this trend “worrying”, as 8% is highly unlikely to be sustainable.
Taking your pension early also means missing out on an extra 10 years or more of compounding and potential investment growth.
3. You won’t accidentally trigger the Money Purchase Annual Allowance (MPAA)
One of the tax benefits of pension saving is the relief you get on the contributions you make. Tax relief is automatically applied at the basic rate of 20%. This means that topping up your pension by ÂŁ100 costs you just ÂŁ80.
Higher- and additional-rate taxpayers receive 20% tax relief too, but they claim an additional 20% and 25%, respectively, using their self-assessment tax return.
Tax relief on contributions applies up to the Annual Allowance. You can contribute up to ÂŁ40,000 (or 100% of your pensionable earnings, if lower) into your pension each year and still receive tax relief.
Taking certain flexible retirement options, however, can trigger the MPAA. This reduces your Annual Allowance to just ÂŁ4,000.
If you’ve reached your planned retirement age and no longer intend to contribute to a pension, this might not be an issue. But if you are a so-called “pension dipper,” accessing funds to cover a short-term expense, you might trigger the MPAA accidentally.
If you still have many years to go until you reach full retirement, you will have severely limited the tax-efficient contributions you can make. This will lower the size of your potential pot at retirement and could even mean you have to work for longer.
Speak to us before you access any pension funds, and we can help you decide if it is the right option for you.
Get in touch
Whatever stage of your retirement you are at, speaking to the professionals can make a huge difference. We can help you retire tax-efficiently, and in a way that makes the most sense for you, so please get in touch. Email enquiries@hda-ifa.co.uk or call 01242 514563.
Please note
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.
