High earners can feel hemmed in by continued tax raids pension savings, but by thinking outside the box they can find ample tax-efficient routes maximise their retirement savings.
Appreciating the finer points of pension planning is essential to avoid pitfalls as well as garner rewards, warns Simon Bashorun of Investec Wealth and Investment.
The pension freedoms recently introduced may be very welcome reforms, yet there is a danger that those going it alone with their planning are not taking enough time to examine the terms of drawdown contracts. With a wide range of contracts with different charging options available, ensuring you choose the most suitable drawdown contract for your pension fund is not straightforward.
Typical charges that the DIY drawdown investor might face when considering a plan are:
Some contracts may combine all of the above into a single percentage charge, others will separate the charges and may operate on a combination of percentage and a fixed fee bases.
Neither is better than the other, however it can make it difficult to compare contracts and decide which plan is right for your pension fund. When comparing contracts, it is important to establish the total overall charge and consider the impact this might have on your pension fund over time. When doing so, confirming the assets on which fees will be charged, and taking into account aspects such as VAT, are also crucial.
Do consider any percentage costs in monetary terms – a contract operating on a fixed cost basis may be more attractive for a larger fund than a percentage charge. However, fixed costs can escalate quickly if additional charges apply to transactions. Careful consideration will, therefore, need to be given as to how the account will be used both now and in the future.
With pensions offering greater freedoms during lifetime and on death, it is important to be clear on what services the contract offers for the charges in question and whether you will require all of those services. As is often the case, the cheapest option may not be the most appropriate, and changing contracts later down the line may prove costly. Regardless of costs, regularly reviewing your drawdown plan is essential to ensure that it remains suitable for your requirements and that your target income is sustainable.
Having warned investors of one of the possible pitfalls in modern pension planning, we should now turn to one of the huge benefits the new regime provides: tax-efficient wealth transfer.
Trusts have long been used to pass assets down to future generations whilst offering a degree of tax-efficiency and control. However, changes to pension legislation made in April 2015 have enabled individuals to pass on their unused defined contribution pension to any nominated beneficiary when they die, without paying a potential 55% pension death benefit charge, which was previously applied to pensions where the deceased member was over 75 or had taken benefits.
The new rules provide the ability for the funds to pass in full within the tax-efficient pension wrapper. The fund can continue to be invested largely free of tax, and also be potentially outside of the Inheritance Tax net. Importantly, the beneficiary will be able to access the inherited pension funds flexibly, at any age, without it affecting their own pension allowances. The income tax treatment of any income drawn will depend on the age of the previous member at the time of death.
On receipt of the pension fund, the beneficiary will also have the opportunity to nominate their own beneficiary who would receive the fund in the event of their death. It is, therefore, quite conceivable that a pension fund could pass down a number of generations giving each the opportunity to draw an income as required.
Whilst the rule changes are welcome, it is essential to remember that pension plans are not a substitute for trusts. They remain, first and foremost, a vehicle to provide an income in retirement. Whilst the pension may have an advantage when it comes to tax-efficiency, a trust, such as a discretionary trust, is the clear winner when it comes to control over the assets and potential protection on events such as a beneficiary getting divorced.
One thing that is clear is the importance of reviewing existing death benefit nominations and the pension plan itself to ensure that the flexibility permitted within the legislation is actually available under your contract. As we have seen, there is much to be gained from appreciating the finer points of pension planning – and much to be lost if one does not.
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