On 6 April the pension revolution begins. Anyone over 55 can choose
to do what they like with their savings – which is either a fantastic
opportunity, or a chance to royally mess up your retirement. So how can
you best manage your money across your later years and remain
financially secure? Our guide sets out the options for the millions of
people now facing some of the toughest financial decisions of their
life.
The bonfire of regulations means that anyone approaching retirement
now faces three simple options when deciding what to do with pension
savings: • Take the lot in one go • Take it in bits • Put it into an annuity
But you don’t have to do one or the other. Pensioners can mix and
match, although before they decide, they should first run through the
checklist of essentials, and work out a retirement budget – see boxes
(below).
Taking it all
From age 55 onwards you’re free to cash in your pension fund, but the
problem is tax. Let’s say David, 65, has saved £100,000 over his
lifetime into a pension, and has just qualified for a full state
pension. First, he can take 25% of the £100,000 entirely tax-free, as a
lump sum, so pockets £25,000 immediately. The remaining £75,000 is then
taxable. David also gets the £115.95 a week full state pension, so his
total pay for the year, for tax purposes, is £81,029.40 (£75,000 +
£6,029.40). As this throws him into the 40% rate, he has to pay £21,815
income tax. So from his £100,000, he is left with £78,185, plus his
state pension.
If your pension savings are much higher, the tax really starts to
bite. Figures prepared by Towry, a pension adviser, show that someone
with a £280,000 fund will lose £80,643 to tax.
The government reckons the tax harvest from people cashing in their
pensions will be so great that it will raise an additional £4bn in tax
revenue over the next five years.
Taking it in bits
This is likely to be the best option for savers who have built up
larger sums. In pension parlance it is called “drawdown”, with canny
savers drawing down only enough to stay below the 40% tax bracket. Towry
reckons that the person with a £280,000 fund, who draws down £42,000 a
year for the following five years, will only end up paying £31,400 in
tax, or less than half than if they took it all at once.
One drawback is that you don’t get the 25% tax-free lump sum all in one go but in dribs and drabs instead.
Putting it into an annuity
An annuity is a regular income, paid every year until the day you
die. You give your money to an insurance company, which in turn agrees
to pay you a fixed income; when you die, the income dies with you. Let’s
say David has £100,000: he pockets the £25,000 tax-free lump sum, then
swaps the remaining £75,000 for a basic “single life” annuity of around
£4,200 a year. This will be lower if he wants some income for his wife
(and to fight inflation) but higher if he is in poor health or was a
smoker. The Money Advice Service has a useful tool that gives you
annuity quotes at moneyadviceservice.org.uk.
Where to start
These freedoms may be popular, but will savers actually be able to do
what they like? Few company pension schemes will be able to offer you
full flexibility. They may allow you to exit with all the money, but
they’re much less likely to allow you to draw down money in bits at any
time. If you want full flexibility, you will probably have to switch
your pension savings to a provider such as Hargreaves Lansdown, Fidelity
or Aegon Retiready and manage it from their “platform”.
As Steve Webb, the pensions minister, said, you could buy a Lamborghini –
but a financial adviser is unlikely to encourage you. Photograph: Oli
Scarff/Getty Images
The options are almost endless. As pension minister Steve Webb said
after the freedoms were introduced, you can go out and buy a Lamborghini
if you want. Or let’s use our example of David, with £100,000, and that
he takes the lot – so after tax he has around £78,000.
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1. Leave it in the bank. Although
interest rates are so low that the £78,000 is unlikely to earn more
than £1,200 a year, under new rules from April 2016 that income will be
largely tax-free, and by shifting it progressively into cash Isas, can become entirely tax-free. You can also access it whenever you want. 2. Leave it with an investment manager.The
rule of thumb among fund managers is that you can probably safely take
an income of about 4% a year without damaging your capital over the
medium term. They do this by investing the money in a mix of corporate
bonds that pay fixed amounts of interest, and companies that pay out
dividends each year. On David’s £78,000, that works out at around £3,100
a year. But the money is at risk – stock markets go up and down.
However, you can transfer the money into stocks and shares Isas (£15,000
a year) which means you can progressively shelter it from tax. 3. Buy a property.The money could be used
as a 30% deposit on a £250,000 buy-to-let property. Post Office
Money’s “First-time landlord” loan is priced at 2.89% initially, so
David’s payments would be £400 a month on an interest-only basis. He
could expect a rent of perhaps £1,100, leaving him with £700 a month. On
paper, this looks attractive – he has turned his lump sum into an
income of £8,400 a year or twice what he might get on an annuity. But
this is the gross amount before taking into account letting fees, voids,
maintenance and so on. Plus, of course, there is tax to pay on the
income.
How much will you spend?
• How much do you need for essentials –
food, heating, council tax, insurance, clothing and household costs? If
you pay rent, or have a mortgage, factor in those payments. • How much will those luxuries – holidays, city breaks, new car, golf club membership – cost? • Do you want to leave anything to children and grandchildren? • How would you pay for a care home?
To avoid these being useless back-of-a-fag-packet calculations, ask
friends who have retired and have similar lifestyles what they spend.
Take Anne Harris (not her real name), who retired two years ago at age
58 after contracting breast cancer. She finds the minimum she and her
husband (they have no children) can survive on in their south coast
bungalow is around £13,000 a year. She budgets to spend £20,000 a year
once her more “discretionary” costs are included. Or there’s Nigel, 62, a
single man used to a more extravagant lifestyle, who reckoned he could
live on £11,000 but has found himself spending more than double that –
and has had to find part-time work to tide him over.
How much have you got?
• How much money do you have? Evaluate all your pensions (find lost ones at the government’s Pension Tracing Service on 0845 6002 537) and your state pension forecast at gov.uk/state-pension-statement or call Future Pension Centre on 0845 600 4274. • Estimate how long you will live Most
of us underestimate how long we are going to live and fail to factor in
the enormous costs of long-term care. Try the longevity calculator at confused.com and reckon on living around 20 years after age 65 if, until now, you’ve been in good health. • Decide if you need advice
Try Pension Wise, TPAS (the pensions advisory service) or Citizens
Advice, all tasked to deliver different forms of guidance (online, over
the phone, face to face). For specific product advice you’ll need an
independent financial adviser – try unbiased.co.uk – but expect to pay
upwards of £1,500. • Do you need the money now, or can you wait?
You can draw 25% of your pension tax-free in one go, or spread it out.
Ask yourself, if you take it in one lump sum what would you use the
money for?
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