The proposed changes to pensions, announced in March’s Budget, open up a number of opportunities, both before, during and after retirement.
We’ve put our thinking caps on to bring you eight ways you can take advantage of the new rules.
1. £10,500 income each year – tax free!
From the 6th April 2015 you will be able to earn £10,500 before you start to pay tax.
So what does this have to do with pensions?
Simple, for people retiring after 2016, the flat rate State Pension will work out to be around £7,500 per year, providing you have paid National Insurance for at least 30 years. That leaves another £3,000 or so, of ‘spare’ Personal Allowance, or to put it another way, tax-free income. This can be filled with income from your pension pot.
For some people this will mean they get tax-relief when they pay into a pension (an £80 contribution immediately becomes worth £100 because the Government adds £20 tax-relief) only to pay no income tax when they retire, because their total income, State Pension plus private pension is below the Personal Allowance.
2. ISAs to produce a tax-free income
ISAs have always been a popular way of providing an income in retirement and they will continue to play a crucial role.
Once the higher Personal Allowance of £10,500 has been used up by income generated from pensions, how can you create a tax-free income?
The answer of course is ISAs (or NISA as they will be known as shortly).
The Budget introduced three key changes:
- The maximum contribution each year will rise to £15,000 from July 2014
- Savers will be able to contribute the maximum amount each year to a Cash ISA; currently Cash ISA contributions are limited to 50% of the overall allowance
- People with a Stocks & Shares ISA will be able to convert into a Cash ISA, allowing investment risk to be reduced
These changes will make ISAs even more attractive to people planning for their retirement, although the tax-relief on pensions, as well as possible employer contributions, should not be overlooked.
The answer to the pension v ISA debate lies in careful planning and advice tailored to your own individual needs and circumstances.
3. 40% tax-relief now, 20% income tax in retirement
For every seven people paying 40% tax at the end of their working life, only one pays 40% tax in retirement.
That means 85% of workers paying higher rate tax can get 40% tax-relief when they pay into a pension, but only pay 20% tax when they retire.
This was of course true before the Budget changes, but with greater access to pension pots now proposed, putting money away in a pension will be more attractive for many people who were previously concerned about how they could access the money.
4. Retire early
Many people want to retire before their State Pension age, which has increased significantly for millions.
Being able to take more money from your pension in the early years of retirement and then reduce it to a more sustainable level when the State Pension kicks in, might be one answer to retiring early.
Of course if you take a relatively high level of income in the early years of retirement, you will need to plan carefully, to ensure you have sufficient income for the rest of your life; cashflow planning and budgeting is key.
The days of working 40 years for one employer, finishing work on your State Retirement Age, and collecting your gold watch are gone.
Many people, especially the growing number in self-employment, now phase into full retirement, perhaps cutting down their working hours and retiring gradually. Some people even return to work after they have retired!
The new found flexibility will allow people to mould the amount of income they take from their pension, to their own individual needs. In some years this might mean more income is taken from the pension pot than was previously allowed, in other years little or no income might be taken.
6. Repaying debt
It is now more common than ever for people to owe money in retirement, perhaps on an Interest-Only mortgage, personal loan or credit card.
The flexibility to take more money from a pension pot at retirement, may provide some people, who previously had no way to repay this debt and therefore with an extra monthly bill, with a solution.
Again, careful planning is needed to ensure that sufficient income will be left after the debt has been repaid and the tax due on the lump sum also needs to be carefully considered.
But for some people, the new rules may offer a way out of debt and allow a more comfortable retirement.
7. More innovative products
The proposals will undoubtedly mean new retirement income products being offered over the next few months.
We have already seen LV= offer a one year Fixed Term Annuity and no doubt others will follow suit.
Of course some products will be good, some bad and others downright ugly, but innovation and greater choice has to be a good thing.
8. Paying for care
More people than ever need some form of care later in life; the number of people needing residential care has risen by a staggering 21% over the past seven years (Source: Age UK)
The cost of care isn’t getting any cheaper. For those people who have carefully managed their pension pot, the greater flexibility proposed by the Government will allow people who need care to draw down more than the current maximum to help pay for these costs.
Furthermore, by taking money from the pension pot to pay for care this could help to leave other assets intact and preserved for younger generations.
A word of warning
The increased flexibility will help millions of people retiring over the next few years mould their pension income to their own individual circumstances.
But the flexibility comes with responsibility, to ensure that you or your advisers manage your pension pot so it doesn’t run out before you die.
We are here to help. Our team of Independent Financial Advisers are experienced in developing retirement income strategies for clients the length and breadth of the UK and are fully aware of the proposed changes.