If you are approaching retirement, you may be thinking about your retirement income. This is likely to come from various sources, including:
• State Pension
• Defined contribution (DC) pension known as a private pension
• Any “final salary” pensions you have from current/previous employers
• Any other investments/savings
• Any additional income i.e. rental properties
Usually, you can access your DC pension pot from the age of 55 (57 in 2028), meaning you could already be preparing to draw these funds. Drawing your pension requires a lot of forethought. HSBC research shows Brits lose £1.7 billion a year to “at-retirement” decisions that may have been made in haste, or simply without sufficient preparation or advice.
One of the main reasons retirees might “lose” money when drawing funds is through tax.
Rushing to take money from your pension, could mean you pay more tax than necessary. Here’s two ways you could take your DC pension, and the tax implications of these withdrawal methods:
When your retirement arrives, you may feel it’s easier to draw all the funds at once so you can decide how to use your money. Generally, you can draw up to 25% of your pension as a tax-free lump sum. However, if you draw the whole fund, the remaining 75% will generally be taxed at your marginal rate of Income Tax. Crucially, this could push you into a higher tax band when added to all other income. So, taking all the fund as a lump sum may not be an advantageous option.
Flexi-access allows you to take money from your pension whenever you want. You can take tax-free cash (usually up to the 25% limit) as it’s needed throughout your retirement; allowing you to take a more ad-hoc approach. Some years you could spend more, while others you may spend less. While helpful in many ways, once you draw taxable income from your pension, this triggers the Money Purchase Annual Allowance (MPAA). The MPAA reduces your Annual Allowance (usually £40,000 or your total earnings, whichever is lower) to £4,000 pa. This means there is a strict limit to how much you can continue to invest if, for example, you continue to work and contribute to your pension while also drawing a flexible income.
Overall, flexi-access is likely to be a more tax-efficient method of taking your pension—although, the implications of the MPAA are worth considering.
Working with a Financial Planner can help you take your pension in a way that suits your retirement goals, tax efficiently. By working with us, you could avoid being one of the retirees contributing to the almost £2 billion lost on inefficient pension withdrawals. Request your FREE Retirement Options guide by following the instructions below…