Time will tell if the mix of tax, spending and borrowing announced last week has the desired impact. However, one significant positive is we can stop speculating and take stock of what has and hasn’t changed, to see what this means for your current and future financial plans.
To help you assess the changes, we have reflected below on the significant benefits of pensions that still remain and what, if anything, you should do now.
Pensions: a powerful long-term savings vehicle
Even with the announced changes to the inheritance tax treatment, it’s hard to beat the considerable tax benefits of saving through a pension to build up a long-term pot for retirement. For basic rate taxpayers, for every £800 you put into a pension, the government will top that up to £1,000. Higher-rate and additional rate taxpayers can reclaim a further 20-25% tax on their pension contributions for a total of 40-45% tax relief.
This boost, enhanced by the power of compounding, really becomes evident over a number of years – it’s essentially a free pot of money that could make a significant difference to your comfort later in life. There are certain steps you can take, too, to optimise your pension’s growth over time, a topic we covered in detail in this recent article.
The investment returns within a pension also compound on a gross (tax-free) basis, meaning the increased rate of capital gains tax announced at the Budget will also not affect pension savings.
When you have grown your pension, you then have vital choices to make: how and when to withdraw your permitted 25% tax-free lump sum, and how to minimise the tax you pay in retirement.
An efficient withdrawal strategy is key
Anyone approaching retirement should – often with the help of a financial adviser – consider their individual circumstances to devise an efficient withdrawal strategy that works best for them.
For example, you may have different options from which to take an income. Alongside your pension(s) you may have a considerable sum built up in an ISA, in a general investment account, or even cash savings. Should you withdraw funds tax free from your ISA first, keeping it invested, and then use your pension for income? How do you maximise, including the tax benefits, money outside of a tax wrapper or held in a savings account?
You can’t assume that the perceived security that cash savings confer will provide the resilience you need over the years – especially with interest rates set to fall further.
An annuity may also become a relatively more attractive option for some of your income needs, as the estate planning advantage to being in flexi-access drawdown reduces. Some people value the consistency of receiving a set sum every year, even if an annuity often produces a lower starting level of income. Whatever the permutations you face, it can be complex to optimise your financial situation before and during retirement – so seeking financial advice is usually recommended.
Using your pension for IHT planning
Many individuals and families use pensions as part of their inheritance tax (IHT) planning. The rule change announced in the Budget (where unused pension funds and death benefits will be subject to inheritance tax of 40% once the ‘nil rate band’ has been utilised) may force some to change their plans. However, it still might make sense to leave your pension untouched and for it to continue to grow.
It’s worth noting, if you are under 75, and you die, your beneficiaries can draw from your pension tax free after IHT is paid. The new regulations, though, may prompt you to consider gifting more assets now or in the coming years assuming you can afford to do so – as if you pass away after the age of 75 income tax needs to be paid by your chosen beneficiary as well as IHT.
Although younger clients may wish to continue growing their pensions until their own plans become clearer, older clients may want to start planning gifts earlier than previously. Establishing how much you can reasonably gift to those you care about, is, of course, key. You should have a clear idea of what you can afford, ensuring your own needs in retirement are taken care of first – cash flow modelling can give you the clarity to make the right decisions.
Even without advice, you can get a clearer view of how your financial circumstances might unfold over time. The wide-ranging tools at MyNetwealth let you plan for your financial future and gain detailed insights into how to meet your long-term goals.
Giving up control of the funds when gifting is often a concern for clients, so starting early with smaller amounts can be sensible. This has the benefit of allowing you to get comfortable with the impact on your financial position, while observing the receiver's behaviour.
Being prepared sooner rather than later
The full implications of the Budget may not be felt for some time, but it can make sense to get ahead of the new environment, and anticipate and plan for the changes, rather than just react to them.
If you would like to know more about how we can help you to evaluate your pension options, and to ensure you are on the right path for retirement, please get in touch.
Please note, the value of your investments can go down as well as up.
Netwealth offers advice restricted to our services and does not provide independent advice across the market. We do not offer advice in relation to tax compliance, personal recommendations with regards to insurance and protection, or advise upon the transfer of defined benefit pensions.
