As most of us will be aware, the Government has announced pension legislation changes in the March 2014 budget, with clarification provided in the recent autumn statement, with these due to take effect from 6th April 2015. Whilst, on the whole, these changes are welcome, one of the key questions our clients ask is whether they will have sufficient income in retirement.
The average money purchase pension fund in the UK is currently c£30,000. A modest fund is unlikely to provide any meaningful value in terms of income, perhaps as little as £1,500 gross per annum. For individuals in this situation, the temptation might be to withdraw the fund subject to tax at their highest marginal rate and retain cash in liquid savings for future expenditure or emergencies. This approach relies upon the willpower of the individual not to spend in the short term, but at least gives control and access.
For individuals with larger pension values, the tax liability for withdrawing the fund in full is likely to be prohibitive where some or all of the fund could be subject to the highest income tax rates. For example, a withdrawal of £300,000 in one tax year (2015/16) would give rise to an overall income tax liability of c£88,000 at an effective tax rate of 39%. Taking income at this level would also give rise to the loss of personal allowance for income between £100,000 and £120,000 and this is an effective tax rate of 60% in this income bracket.
An alternative to withdrawing the full fund in one lump sum is to take value over a number of years. In the same scenario, £300,000, again after the taking of 25% as tax free cash with no other income in that tax year and drawing £37,500 per annum over 6 years would give rise to an overall tax liability of c£32,000 which is an effective tax rate of 14%. A vastly improved situation!
Of course, an individual does not have to take some or all of the capital but can instead, rely on a sustainable income through the new Flexi-access Drawdown route. This allow’s the capital sum to remain invested with income delivered by taking the income directly from the fund value. The risks associated with this are that the funds can go down in adverse investment conditions but this at least provides the opportunity for flexibility over how these benefits are delivered and how monies are passed on to beneficiaries in the event of death.
What would we consider as a sustainable level of income? This depends on the level of risk that an individual is prepared to take. If we accept 50% of the fund held in equity based investments we would expect the portfolio to provide capital growth including natural income, (interest and dividend returns), of between 3%- 5%. Thus, on the basis of a fund value of £300,000 then a maximum income of £15,000 might be sustainable over the medium to longer term. A lower level of income or a higher return will be needed if inflation is to be allowed for. This income should be added together with any state pension benefit entitlement and other - incomes such as interest on deposits - to give an overall income figure. These figures can then be compared with current expenditure requirements to give a feel as to whether overall income will be sufficient.
Annuity purchase remains an option whereby monies are paid to an annuity provider who guarantees the income for life. This guarantee, whilst beneficial, may now be thought of as too restrictive and doesn’t allow the flexibility that most people require. One consideration here is a hybrid of both the annuity and Flexi-access Drawdown route which creates a level of secure income through annuity purchase, with the remaining income being generated by investment returns.
We mentioned the tax free cash entitlement in the above examples; there are no Government plans, (to our knowledge), for removal of this tax advantage but this should always be kept in mind. Pension benefits are available for most individuals from age 55 and consideration over taking tax free cash on or around that age will at least allow this valuable benefit to be crystallised.
Kreston Reeves Financial Planning Ltd is an independent financial advisory and provides specific advice in relation to pension provision and the taking of retirement benefits along with other financial planning aspects. We are familiar with the options available and successfully manage the retirement plans for a significant number of individuals. If you would like to discuss options available to you, please do not hesitate to contact us
Kreston Reeves & Co LLP (Registered number in OC328775, registered office: 37 St Margaret's Street, Canterbury CT1 2TU) is registered to carry on audit work and is regulated for a range of investment business activities by the Institute of Chartered Accountants in England and Wales. A list of members’ names is available at our registered office and details of the licensing bodies for our insolvency practitioners can be found at our website. Kreston Reeves Financial Planning Limited (Registered number 3852054, registered office: 37 St Margaret's Street, Canterbury CT1 2TU) are authorised and regulated by the Financial Conduct Authority. All of the above addresses are registered in England.