We had a client, Ms B, in her sixties and nearing retirement. She was planning to retire to Spain and wanted to get her pension plans sorted out, tidied-up, amalgamated etc. She had a number of pensions with different providers adding up to something in the six figures.
Ms B understandably wanted to take as much as possible tax-free. Normally with pensions, somebody – if they have, say, £100k in the pot – will be able to take 25% of it tax-free. There’s also the option of an annuity purchase which is a guaranteed income for life. In the annuity scenario the insurance company will determine how much can be taken per annum – which will be subject to tax at your marginal rate.
That annual figure is determined by a number of factors the insurance company has to consider – the amount accrued, your age when the payments start, and various health-related things such as whether you are a smoker. There is no option to change that level of annuity income – either reduce or increase it, or to negotiate any change to it.
For people who are relatively young the annuity rate might not be that great, but for older people the annuity rate will be higher. The possible problem with starting the annuity at a later age is that while although the payments might be higher, the recipient might pass away with the outstanding annuity effectively dying with them. The annuity may then be passed to a partner/beneficiary, but, again, it will die with them as well.
So, back to Ms B who had ruled out purchasing an annuity. We were looking at a solution called ‘drawdown’ – which meant she would dictate how much annual income she wanted from her pension pot.
Drawdown is a flexible investment which remains invested for life. You can still take the 25% tax-free part, but you also determine how much you want each year. This is where we come in. Depending on how much you want on an annual basis we will then assess how that will leave you positioned at say aged eighty, eighty-five, or older.
Our job is to let clients know how long that money will last. And that, of course, is determined by how much is taken out each year.
We might see that a client is heading to a position where they’ll run out of money by the age of just seventy-eight, in which case we’ll advise to reduce the annual amount taken. On the other hand, there might be enough in there to see the client through to the age of 113.
If that’s the case, we’ll let them know and they can draw more each year and perhaps look at two annual holidays not the one – Covid restrictions permitting, of course!
We review this position every year for every client. No one wants potential surprises. We generally look to use calculations that will see a client paid through to their late eighties or early nineties. Again though, this of course can be reviewed and adjusted as the client gets older.
Back to Ms B again. She had decided on a suitable drawdown contract for her pension. The difference with Ms B though was that she was still working – as a consultant in law. She would have two income streams to manage and naturally wanted to minimise the tax implications. By taking a reduced income for her consultancy work she moved into the basic rate tax bracket. However, taking a pension could significantly increase her tax status and liability.
So instead of taking her tax-free amount from the pension pot as a lump sum, we looked at having it drip-fed as an income over a period of months. The provider Ms B was with only allowed that scenario for a period of up to twelve months, so we moved her to a company that allowed her to take tax free cash as an income in perpetuity. It didn’t affect her tax situation and Ms B was still able to draw an income as a consultant.
Ms B isn’t a typical client. The combination of a larger than average pension pot and her decision to continue to work as a consultant in a well-paid industry presented us with some food for thought in how to manage this efficiently, and in line with what she wanted. Her case is a good example of moving things around to gain tax efficiencies and in turn a much better position for the client.
This was far a more effective result for Ms B than if she’d gone down the road of taking a tax-free lump sum in one go and just sticking it in a bank or building society. It would have earnt little and then would have potentially been liable for tax at a later date.
Our experience of the marketplace and different product providers gave us a head start in getting to this position for Ms B. Taking tax free cash as an income on an ongoing basis is not that common, so in being able to do this we satisfied Ms B’s needs, creating a situation whereby she had parallel incomes – importantly, one with no tax liability.
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The information contained in this article is provided in good faith and is provided for information purposes only.
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No individual investment advice is given, nor intended to be given, in this article and no liability will be accepted in respect of any action you may take as a result of reading this material.
If you are unsure whether any particular investment or any specific course of action may be suitable for you, you are urged to take independent investment advice.
