If the proposals announced in last month’s Budget are implemented without change, anyone over 55 will have far greater access to their pension pot after April next year.
Each year around half a million people retire; so how can those retiring over the next 12 months, take advantage of the new rules from 2015 onwards but replace their ‘lost’ income now?
Access the tax-free lump sum?
One option is to take some or all of tax-free lump sum from your pension, use this to pay your bills for 12 months and then make your final decisions in April next year, when the new rules are finalised.
If you take this option, you will need to find a temporary home for the rest of the pension pot for at least a year.
Assuming you want to take no capital risk with your pension pot, and we’d suggest that investing in stocks and shares for one year isn’t sensible, there are essentially two options:
A Fixed Term Annuity gives you access to your tax-free lump sum and then a known and guaranteed maturity amount at the end of fixed term. Until recently the shortest term available was three years, however in an innovative move after the Budget, LV= now offer a one year Fixed Term Annuity.
On the other hand a SIPP can invest in a wide range of assets, including deposit accounts, which are an ideal alternative short-term home until April next year.
So, which offers the best return over the course of the next year?
We’ve crunched the numbers for a range of pension fund values and this is how the two options compare.
|Pension pot size before tax-free cash||Pension pot size after tax-free cash||Fixed Term Annuity maturity amount||SIPP final value||Difference|
|£50,000||£37,500||£37,613||£38,097||SIPP better by £484|
|£100,000||£75,000||£75.228||£76,347||SIPP better by £1,119|
|£150,000||£112,500||£112,832||£114,597||SIPP better by £1,765|
|£200,000||£150,000||£150,450||£152,847||SIPP better by £2,397|
The SIPP and deposit account combination offer better results for all the fund sizes we considered, with the gap between the two options widening for larger pension pots.
However, in our experience the option of using a SIPP and deposit account combination is often overlooked by investors and advisers.
We’ve made some assumptions which you should know about:
- To keep the results constant we’ve not included any advice fees, which would be payable if you consulted with an Independent Financial Adviser
- The Fixed Term Annuity figures have been provided to us by LV=
- When calculating the final value of the SIPP we have used the charges of the Liberty Option SIPP and assumed no set-up fee and an annual fee of £150
- If, at the end of the year, the funds were transferred out from the Liberty SIPP to an alternative provider, a fee of £100 + VAT would be charged
- We have assumed a one-year fixed rate of 2% for the deposit account to be held in the SIPP, both the Punjab National Bank and Bank of Baroda pay these rates
“What are the downsides of spending the tax-free lump sum?”
Taking the tax-free lump sum on to live on, until the rules are finalised and you can make more informed decisions, may sound like the perfect way of ‘getting the best of both worlds’, but there are downsides:
- By taking and spending the tax-free lump sum you will reduce the final level of income available to you
- If you die before taking the tax-free cash, the whole of your pension pot would be available to your dependents as a tax-free lump sum. Once you have taken the tax-free cash any lump sum paid on death would be taxed at 55%
- If you ultimately decide to buy an Annuity in April next year, it is possible Annuity rates may have fallen, of course the opposite may also be true and rates could have risen
What are the other options?
To retire now, many people will have no choice but to access their pension pot.
But as we’ve pointed out, there are downsides. So what are the other options?
- Carry on working until next April. Not an appealing thought perhaps, but it might be better than the downsides of taking your pension before the rules change
- Cut back on spending, again not necessarily palatable, but certainly an option
- Use other savings to tide you over
If you absolutely have no other choice but to take money from your pension, it makes sense to take the absolute minimum you need.
Not only will these mean you have a higher income in years to come, it will also allow some of the pension fund to be paid out without a deduction for tax, should you die.
Complicated isn’t it?
Turning your pension pot into an income was already complicated; the proposed changes in the Budget have made it even harder to be sure you are making the right decisions.
But we’re here to help.
If you are approaching retirement, would like advice on your options and want to know how the Budget affects you, call one of our IFAs today on 0115 933 84330115 933 8433, alternatively enquire online or email email@example.com