How pension freedom
rules affect your retirement


Pension freedom has been with us for two years now, and while concerns that people would blow their pension on fast cars and a fast lifestyle appear to be unfounded, there is still a need for retirees to ensure their pension will last as long as they do.

The amount of money being accessed under the pension freedom rules two years on is accelerating, according to figures from HM Revenue & Customs. From Q2 205 to Q1 2016, 232,000 people took out a total of £4.3 billion, while in 2016 to 2017 over the same period, 393,000 people took £6.45 billion from their pensions – an increase of around a third in a single year.

So, clearly the ability to take your pension as and when it suits you is a popular development for retirees, especially having retained the ability to take the first 25% of any payment tax free.

Recent research from Prudential shows that while two thirds of advisers believe the new rules will improve their client’s retirement planning, too many people are still relying on house price inflation or an inheritance to help fund their twilight years.

The pension freedom rules have been good in as much as they have reinforced that a pension is simply a very tax-efficient investment.

In saving for retirement, people should consider building many different types of investment to create the money they will need when they retire in the future and not just through pensions. It's therefore vital to build a plan, specific to you to consider how to access the benefits of these investments, in their various forms, across your retirement.

Ideally, you should plan ahead about the kind of retirement you want and what you will need to take from all your investments, including pension, in order to achieve it.

Whilst it would be great to build enough assets to be able to live on interest and other natural income like dividends, for most, retirement will involve spending a combination of capital and income throughout your life.

The trick is to ensure you have enough to draw to meet your needs, and that it will last long enough to sustain you throughout the rest of your life. This is best done with the help of an independent financial adviser (IFA), as you should consider all elements of your investment portfolio and its performance, including the possibility of periods of poor returns.

If you elect to draw capital and income from investments to provide your retirement income, then the sustainability of the funds can be radically changed if funds suffer poor returns at any time, but particularly in the early years.

For some, the security of an annuity is the solution that provides peace of mind, even though interest rates are low and annuity is not as flexible as a drawdown. However, the attraction of flexibility of access to capital and income, lump sums on death and leaving a fund for future generations are enough to persuade them that the risks of the sequence of returns are worth it, but they come with a risk that needs to be understood and managed.

It's essential to have a clear view of what your retirement will look like financially and consider how and when you will need additional capital or income to ensure you have enough to live on. Obviously the grater the need for withdrawal, whether capital or income, the greater the likelihood that your funds will run out.

One way of planning the structure and impact of these withdrawals is to use a cash flow modelling tool that provides the opportunity to change assumptions and see the future impact of changes.

Drawing money from an authorised pension plan, while it remains fully invested, is called flexi-access drawdown. This allows you to take as much or as little as you need from your pension over time. 25% is deemed free from income tax, whilst any additional is taxed as income and therefore subject to your marginal rate of income tax. This reflects the tax relief paid whilst building the investment.

Flexi-access drawdown can be used for estate planning too. In most cases, your pension is held in trust meaning that in some cases, but not all, will be outside of your estate for inheritance tax (IHT) planning.

This fact and the new flexibility has meant that those with significant assets can consider not spending capital and income from their pensions, and rather spending their estate to create a win-win with regard to inheritance tax.

It's essential that the trustees of the pension know your wishes on death and therefore ensuring a nomination has been fully completed is not just very sensible planning but essential.

Under the old pension rules there was a 55% tax liability on residual funds on death after 75. This is no longer the case and on death before 75, any residual fund can either be paid or left to your beneficiaries in a successors pension that they can draw at any time tax-free.

If you die at age 75 or above, then funds paid would be taxed at the beneficiaries marginal rate with the option of a successor's pension available, such that the tax is only payable when they draw the benefits.

Whilst vital to understand and plan around death benefits, we must not lose sight of the fact the funds, first and foremost, are to provide you with an income for your lifetime, however long it may last. You may face some surprise costs too, such as the need to have long-term care if you find yourself in ill-health towards the end of your life, and your pension fund can help provide choice and flexibility around these difficult decisions.

Whilst, as mentioned earlier, an annuity purchase has for many been discounted, but it's sensible to give it a second look. It can provide valuable peace of mind around a part or all of your retirement planning and the new rules that were announced alongside the flexible rules have often been overlooked.

Lifetime annuities can now provide ongoing income on death to any beneficiary nominated and not just dependent and through the use of 20 or 30-years guarantee, value protection they can provide for funds to be left to beneficiaries but with the benefit of the guarantees an annuity bring.

For some, they are absolutely the right solution to generate a retirement income from your pension. Enhanced rates of income are often available where you are suffering, or if you have a condition such as asthma or diabetes, which could shorten your life.

All of these decisions have to be made with an eye on how much risk you are prepared to take with your retirement savings, and using an adviser with a specialist knowledge will help you achieve this.

With more than 25 years of experience and over 160 advisers nationwide, AFH Wealth Management is one of the UK's leading financial firms.

If you would like to discuss your retirement plan with an independent financial adviser, please do not hesitate to give us a call, or fill in the enquiry form below and we'll be in touch.

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