From the 6th April the new Pensions Freedom rules, will allow anyone over the age of 55 to cash-in their entire pension pot and spend the money as they like.
When the new rules were announced last year, Steve Webb, the Pensions Minister, famously talked about people spending their pension pot on Lamborghinis. Although this is unlikely (the average pension pot in the UK might just stretch to the cost of the tyres on such an expensive car) if you are thinking about taking advantage of the new rules and cashing-in your pension, you should take some time out to make sure you really have thought the consequences through.
To help you, here are eight questions you should answer before you take the plunge and cash-in.
#1: Do I already have enough income (now and in the future)?
Most people paid into a pension to give themselves an income in retirement; just because the rules now allow you to take it all as a lump sum doesn’t mean you still don’t need the income.
Before you cash-in your pension pot, sit down and work out a detailed monthly budget showing all your expenditure, including the expenses which come around each year like Christmas, birthdays and holidays.
Now look at your existing after tax income, is it enough for you to live on? Will the income continue forever, as the State Pension will, or will it come to an end at some point, for example if you give up work?
If you don’t have surplus income, you probably can’t afford to cash in your pension, no matter how tempting it might be. Even if you do have a surplus, there’s no guarantee it will be there forever…
#2: Is my income inflation proofed?
When you are working through the calculations outlined in #1, remember to factor in inflation; your bills will rise each year but will your income?
You might be able to pay your bills now but what about in years to come?
In some cases it might not be the right option to cash-in your pension, or indeed to take an income, but leave the money invested for use in the future when you really need it.
#3: When will I get my State Pension?
For many people their State Pension will provide a significant proportion of their retirement income. It is therefore vital you know exactly when it will be paid to you and how much you will get, before you make any decisions to cash-in your pension.
#4: Will I need any lump sums in the future?
It isn’t just about income though.
You may need access to a lump sum of money in the future. For example to repay a mortgage or other debt, help out your children, alter your house, replace cars or meet the cost of care.
You might have other ways of paying for these things, but if not, and you’ve spent your pension unwisely, you could find yourself in an extremely difficult position.
#5: What will I do with the money?
Some pension experts are concerned that people will simply take money out of their pension to reinvest elsewhere, perhaps into a savings account, ISA (Individual Savings Account) or even a Buy to Let property.
By taking money out of the pension, you will probably trigger a tax bill (more of that in a moment), but you then need to consider whether or not the new investment will perform as well as your pension could with a little care and attention.
Many people don’t trust pensions and see now as the ideal opportunity to move away from them. But, a pension is a very tax-efficient way of investing, why take your money out, pay tax, only to generate a lower return?
Before you take your money out to reinvest elsewhere run the numbers, you might be surprised at how attractive a pension looks.
#6: How much tax will I pay on the lump sum?
We are concerned that many people will take the decision to cash in their pension, only to receive significantly less than they expected due to the tax they will have to pay.
Any amount you take from your pension, above the 25% tax-free lump sum, will be added to your income and then taxed. If the amount takes you into higher rate tax, you will lose 40% of the money withdrawn, which could come as quite a shock.
Before you cash in your pension make sure you know exactly how much tax you will have to pay.
#7: Is there any way to reduce this tax bill?
If you really think cashing in your pension is the right thing to do, you should consider ways of reducing the amount of tax you pay.
One option is to take money out over the course of different tax years, this could help to reduce the amount of tax you pay, especially if you don’t currently use your Personal Allowance (the amount you can earn before you start to pay tax) or if taking the entire pot, as one lump sum, would mean you pay higher rate tax.
#8: Should I take Independent Financial Advice?
Finally, if you are unsure about your options, or even if it’s just to get a second opinion, consider taking independent financial advice.
Whilst giving people more choice, flexibility and freedom, the new rules are far more complex than before, which also increases the chance of making a mistake.
Yes, you will have to pay for advice, but this could save you money in the long run.
We’re here to help
If you are thinking of cashing your pension in, are confused about your options or just nervous about making decisions on your own, our team of advisers is here to help you.
Call us today on 0115 933 8433 or email info@investmentsense.co.uk all initial discussions are without cost or obligation; we’re here to help.
Please note: Buy to Let investments are not regulated by the Financial Conduct Authority (FCA)
