This is a big question that I get asked by clients when they are nearing retirement. We spend so much of our lives working and building up our pot of money, that when we come to think about retirement and needing to use this money it is a big mindset change as well as a practical question of how does it all work. So let’s talk it through.
Consider tax
Income Tax – everyone gets a personal allowance which is currently £12,570 per tax year that you do not pay tax on. Therefore it is a good idea to take enough income to cover this so that you use this tax free allowance.
Inheritance Tax – pensions are not in your estate, so if you die then they are not included in any inheritance tax calculations. Therefore, you should look at taking an income from investments such as ISAs, which are part of your estate, to reduce any IHT liability.
So deplete your investments first, at the same time as making sure you are taking enough income to use your tax free personal allowance.
Taking money from pensions . . .
There are two ways of taking money from your pensions: annuities and drawdown.
Annuities are when you take your pension and buy an annuity from a life company. In return for your retirement pot they will pay you a guaranteed income for life. So when you die it is gone (unless you pay for a spouse’s pension too). You do not need to worry about the stock markets and how investments do and running out of money as you get a secure income.
Many people do not go for this option now that you do not have to (you used to have to buy an annuity by age 75 but legislation changed). This is because annuity rates are low, you don’t get a particularly high income for your money, and once you and your spouse are dead, then the money is gone, you cannot leave it to your kids.
However, it can be a good option and you do not need to put all of your money into an annuity, you could just put some in for a stable base on top of your State Pension.
Most people go for the drawdown option. This means that you keep your money invested but can take money out as and when you need it.
25% of your pension money can be taken out as tax free cash and the rest is an income. You do not have to take the tax free cash in one go and bearing in mind that if you do take it out and then keep it in your bank account, it is now liable to inheritance tax as above.
It can be really flexible. So let’s say that you decide to retire at age 60 and you have some fun plans to travel and enjoy your life with no work, whilst you are young enough to be able to do lots of things. Therefore maybe your income from pensions and investments needs to be higher at this point.
Then at age 66 your State Pension will start, so you may no longer need to take quite so much money from your other assets.
At age 80 you may start to slow down and not be able to do so much so your income needs may go down, before ramping back up again in your 90s when you need some help / care.
Annuities cannot offer this flexibility, but drawdown can.
Everyone is different and no one solution fits everyone, we need to plan for each person individually to see what your income needs are and how we can give you that money in the best and most tax efficient way.
Let’s chat 😊.
