Howard Goodship, chartered financial planner and member of the Ringwood financial planning team has written his sixth article in a series on Understanding Investments. To read other articles in the Understanding Investments series please see the articles below or visit our New to Investing web page.
Understanding Investment Articles
'With greater choice comes greater responsibility”- a play on a famous quote by Voltaire, but so relevant for the financial options now available since “Freedom and Choice in Pensions Legislation” was introduced in 2015. Now I would like to simplify the high-level options available.'
What factors determine when you decide to retire?
Decisions about retiring can be driven by a number of factors including health, availability of work, enjoyment at work, family circumstances and fulfilling long held dreams & aspirations. The decision may be to reduce hours and ease your way in, or to fully retire. Whatever the circumstances, affordability will be considered but often in a haphazard, ad-hoc way.
How we utilze cash-flow planning to plan for your retirement
Limiting or ceasing the ability to earn an income can be a scary thought and is certainly a huge decision. Understanding the effect of inflation on your income needs throughout retirement (at 3% inflation your expenditure will double over 24 years) and other significant capital requirements needs more than a “finger in the air” analysis. At Lonsdale Wealth Management, we utilize cash-flow planning tools to help clients understand whether retirement is affordable and just as importantly, sustainable. Once affordability has been identified, decisions on the most effective way to generate retirement income can be made.
Retirement income - guaranteed or flexible income?
Retirement Income is divided into guaranteed income and flexible income. Guaranteed income would include Defined Benefit Pension Schemes, the State Pension and Pension Annuities. Flexible income includes Pension Drawdown and income from capital and investments, with rental income classed between the two, as it is secure but can be subject to void periods. Expenditure is split into basic and discretionary. In an ideal world, all basic expenditure and all regular discretionary expenditure would be covered by guaranteed income, but if that isn’t achievable at least all basic expenditure should be covered.
You can currently access your defined contribution pension savings any time after age 55 although the minimum age is expected to increase to 57 in 2028 and remain 10 years below state pension age thereafter.
Defined contribution pension options
You have four broad choices and for each option, 25% of your pension savings can be paid tax-free:
- Secure Income
Exchange your pension savings for an annuity provided by an insurance company which is then guaranteed for the rest of your life (with options including a dependant’s annuity). Annuity income is subject to income tax.
- Flexible Access
Take the income you need when you need it. The money remains invested and you draw a variable level of income for as long as your money lasts. Withdrawals are subject to income tax.
- Cash Payment
Have all your savings paid as a cash lump sum, with 75% of the fund subject to income tax.
- Leave it for now
There is no requirement to draw your savings from your pension and the fund can be passed down to a nominated beneficiary (and through different generations), often outside of your estate and therefore exempt from Inheritance Tax. The 25% tax free lump sum is lost if not taken during lifetime, but your funds can be paid tax-free on death before 75 (taxable on death after 75).
Howard Goodship, chartered financial planner and member of the Ringwood financial planning team said:
'As you can see, there is now much more choice available and pension savings are another tax advantageous wrapper to consider alongside other tax efficient products including ISAs. When planning your retirement strategy, the whole picture should be considered to achieve the most tax-efficient and sustainable outcome. If you require pension advice contact one of our Lonsdale wealth management independent financial advisers. Remember it is never too late to start planning for your retirement and our financial consultants offer a free initial consultation.'
The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested. The contents of this article are for information purposes only and do not constitute individual advice. The Financial Conduct Authority does not regulate Cash-flow planning or tax advice.