By Neville Pereira, Lubbock Fine Wealth Management LLP
With dramatic changes to pensions set to come into effect in April, it’s essential to be aware of the potential impact to your financial future.
Pensions are an essential, if often overlooked part of many people’s financial planning. The slow burn and long term nature of pensions mean that many never adequately pay into or properly understand the benefits they can provide. From April 2015, the over 55s will have unlimited access to their pension pots.
While many see this as a good thing, it also gives the chance of financial ruin without proper consideration of the ramifications of poor money management.
Here’s a quick rundown of some important factors that you might want to discuss with your financial advisor.
The tax advantage of a pension
Tax relief is available on all contributions made into a pension fund. This means income tax relief is available at your marginal rate and for some this means up to 45% income tax relief. It’s important to remember that when you take pension benefits you can only take 25% of your accrued pension fund as a tax-free lump sum, everything else is taxable as income at your marginal rate.
Pensions vs ISAs
Pensions have long been a favourite way to make long term savings due to the tax relief mentioned above. However, the flexibility of being able to withdraw money at any time is a big draw of ISAs, particularly when compared with money being locked away for years in a pension scheme. There is the added benefit of not paying income tax on cash withdrawals from ISAs, but it’s important to bear in mind that you’ve already paid it in the form of taxable income. For the over 55s, however, due to the inheritance tax advantages, are pensions the better option?
Unexpected tax bills
Being presented with a large amount of previously untouchable money sounds like a dream come true, but research by Ipsos MORI warns that many could be stung with a sudden and unexpected tax bill if it’s withdrawn in one go. This is due to the fact that after the 25% tax free lump sum, the remaining 75% of the pension withdrawal could be taxed at an emergency tax rate as opposed to your marginal rate. Consulting with your financial advisor / accountant could help you to minimise your tax by making your money work for you.
Living in retirement
It might be tempting to take your pension pot money and go on a spending spree, but an average British pensioner is expected to live for around 20 years from age 65 according to Age UK. This means a pension will become absolutely essential in later years.
Cash flow-based financial planning is a proven and methodical approach to ascertain how much money you will need to put aside to ensure you have enough money for your expected life expectancy.
If you would like to know more about the issues raised in this article, please do get in touch with me. 020 7490 7766 or firstname.lastname@example.org.