Pension dilemmas often bring clients through wealth managers’ doors, but these invariably uncover other areas in need of investments and financial planning.
The pensions reforms announced in the 2014/15 Budget are nothing short of revolutionary.
Pension access from age 55
From April 2015, investors will be able to access their entire pension fund from the age of 55 (although this is rising to 57 from 2028). As so sensationally reported by the media, retirees could even withdraw their entire pension pot and spend it as they wish.
It can safely be assumed that most people will not take this option, however, and so will be looking to either invest their funds to provide an income or purchase an annuity (although the popularity of this option is dwindling, as outlined below).
There is a lot for savers to consider from a tax perspective. The first 25% of your pension will be tax free, with the rest taxed at the highest marginal tax rate which applies to you. The income from your pension will be taxed along with any other income and so retirees could find themselves being pushed into a higher income tax band. Therefore, it may be more tax-efficient for you to withdraw your pension pot in tranches, taking the untaxed quarter first and taking the remaining 75% taxable amount out at a later stage.
A good wealth manager will be able to come up with a range of investment strategies which will help mitigate your tax liabilities in retirement. They may, for example, advise tax-efficient investment products like Enterprise Investment Schemes which could offer significant income, capital gains and inheritance tax advantages. Minimising the IHT bill on your estate will naturally also be something you are thinking about in your later years. There are many strategies wealth managers can deploy so that as much of your estate as possible can be left to your loved ones, including any remaining pension monies.
Freedom over pension income
Currently, most retirees are restricted as to how much income they can draw from their private pension fund. From 2015, these pension drawdown limits will be scrapped, allowing investors to take as much income as they wish.
Under the new regime, investors will be able to use income drawdown to fund their retirement, rather than having to purchase an annuity which will give them a secure amount of income for the remainder of their life. This flexibility over when and how much income you take is obviously more “life-friendly” but it can also generate significant tax advantages. Additionally, annuities have been heavily criticised recently for being poor value, so many investors have welcomed the pensions reforms as an opportunity to make their wealth work harder for them.
However, as previously mentioned, this freedom to invest your pension carries a great deal of risk. On the one hand retirees will certainly not want to stint themselves during their golden years, yet on the other the thought of running out of money in old age is a terrifying prospect for most people.
With the stakes so high, most would agree that taking professional investment advice is an absolute necessity. A good wealth manager will first gain a holistic overview of your wealth and then work with you to devise a retirement investment strategy which is optimal for your circumstances. This will involve complex deliberations over risk and return, and several longevity scenarios will have to be factored in. It may be for example, that a younger person can tolerate more volatility in their investment portfolio because they have other income sources and don’t yet need their pension income. Knowing that they have more time to recoup losses might mean that such a person could favour a more aggressive investment strategy than someone who may soon require their money to fund residential care, for example.
A further change to the pensions regime is the new possibility of those taking income still being able to contribute to their pot. Post-April 2015, those who have entered drawdown may still be able to make pension contributions up to a £10,000 a year limit. Previously, those taking pension income could make no further contributions at all (to stop people getting paid their salary straight into the pension fund and therefore avoiding tax on the first 25% of the amount).
Most would agree that the pensions reforms coming into force next year are a huge step in the right direction, giving savers the freedom to invest their pension pot in a way which suits their unique needs. However, devising an appropriate investment strategy for managing that money long term will usually call for the expertise of a professional adviser. The good news is that investors could be getting a lot more out of their pension savings, but the bad – for those who fail to take proper, timely advice – could be very bad indeed.
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