3 benefits of taking your pension last
The retirement plan you have in place will be based on your circumstances, aspirations, and intended retirement date.
Although your long-term goals might not change, external factors can. The introduction of pension freedoms and the financial instability of the coronavirus pandemic might have forced you to re-examine your plans. You might even be considering taking your pension early.
Retirement is an important life milestone and making the right decision at the right time is crucial. Poor or ill-timed choices can have far-reaching consequences.
One option – and one that doesn’t necessarily spring to mind – is taking your pension as a last resort, or not taking it at all, if you can afford to.
There are several reasons why you might consider this. Here are three of the most important.
1. You can pass unused pension funds onto the next generation tax-efficiently
Planning how to pass your estate onto the next generation in the most tax-efficient way can be complex. Ensuring you have enough money in retirement to live your desired lifestyle, without leaving too much and creating a huge tax liability, is a difficult balancing act.
One area you might overlook is your pension provision.
Once you take pension funds from a given scheme, they become part of your estate for Inheritance Tax (IHT) calculation purposes. Unused funds, however, do not.
You can pass these onto whoever you choose and can do so 100% tax-free in some circumstances.
You choose your pension beneficiary through your pension provider – not via your will. You’ll need to complete an Expression of Wish form so speak to your provider to name a beneficiary or check one is in place. Remember that certain life milestones might shift your priorities, so be sure to amend your beneficiary if required.
If you were to die before the age of 75, your unused pension funds can be passed to your chosen beneficiary for that scheme, tax-free. Your beneficiary will decide how they access the funds. They might choose not to access them at all. Unused funds, which remain in a pension environment, could pass on to their beneficiary in turn.
Where death occurs after the age of 75, your unused pension provision will still pass to your chosen beneficiary, but there will be tax to pay, at the recipient’s marginal rate of Income Tax.
If you think you can afford not to take one, or all, of your pensions, the unused fund could be a great way to pass your wealth onto a chosen beneficiary in a tax-efficient way.
2. You might be better off using savings to fund your retirement while allowing your pension to grow
Certain savings and investment products, such as pensions and ISAs, are incredibly tax-efficient. Making use of these tax-efficiencies for as long as possible could mean you are better off in the long term.
Taking your pension and accessing the 25% tax-free element might be tempting. You’ll have cash in hand to pay off a mortgage or to gift to children and grandchildren.
However, not only do pension contributions benefit from tax relief but, as we have seen, they are also exempt from IHT. Taking advantage of these benefits, along with the effects of compounding on your invested pot, might be your best option.
You’ll need to be able to afford it though. That will likely mean having sufficient savings, or other income such as that from buy-to-let properties, to fund the early years of your retirement.
3. You could avoid a hefty bill while maximising future savings
Taking large lump sums from your pension, especially while you are still working, could result in a large tax bill. Although the first 25% of an uncrystallised funds pension lump sum (UFPLS) is tax-free, the rest is taxed as income.
Your Personal Allowance for the 2020/21 tax year is £12,500. Income Tax is payable on any income above this and it is feasible that a large lump sum payment could mean you paying higher- or additional-rate tax.
You’ll also need to be mindful of the Money Purchase Annual Allowance (MPAA). You trigger the MPAA when you access taxable defined contribution (DC) pension funds. It lowers your Annual Allowance – the amount you can contribute to your pension annually and still receive tax relief – from £40,000 to just £4,000.
Once you trigger the MPAA, you are stuck with the lower allowance. This severely limits the amount of pension savings you can make from that point, affecting the tax relief you receive and the overall size of your pot.
Get in touch
Deciding how and when to take your pension can be a difficult decision, as can deciding not to take it at all. There are benefits to leaving your pension until last, but it won’t be the correct choice for everyone.
We can help you decide whether you have sufficient savings and income from elsewhere to delay taking your pension.
Please get in touch if you’d like to discuss your retirement plans or if you have any questions about leaving your pension pot invested as a last resort.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of, and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.
This article is distributed for educational purposes and should not be considered investment advice or an offer of any product for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. Past performance is not indicative of future results and no representation is made that the stated results will be replicated.