Everything but the pension…

George Osborne has enabled people to spend their pensions how they wish. But Fiona Tait from Royal London argues that some people should try to spend their pension last of all.

George Osborne has been really rather clever. At the same time as telling people they could spend their pensions as they liked, he gave some very powerful reasons why they shouldn’t. In fact for some people their pension should probably be the very last thing they spend.

Here are my top 5 reasons to stay invested:

Taxation

Pensions are taxed on an EET basis:

  • Contributions are exempt from income tax
  • Investment returns are exempt from income and capital gains tax
  • Withdrawals are taxed at the recipient's marginal rate.

This means that, once they have been invested, savings are more tax efficient inside the pension than outside it.

This is particularly true in the case of inheritance tax. Assets held within a pension plan are outside of the plan holder's estate, and what is more, need never actually enter the estate if the funds are not required to provide income or spending money.

These monies can also be passed to a nominee(s) and be held outside of their estate until they are actually needed (read more about how death benefits work now). However, every other investment the client owns is likely to form part of their estate and be potentially liable for inheritance tax on death.

Future options

For anyone over the age of 55, a pension plan is effectively an immediate access investment account.1 Clients who want to continue saving or maintaining a rainy day fund would do well to utilise their pension plan for this purpose. Putting off taking income means more will probably be available later, and if the worst happens the fund can be passed on to a beneficiary (see above).

Lastly, the new lump sum withdrawal option ensures that funds are accessible at any time if unexpected expenses arise.

Investment options

I have written elsewhere about the dangers of taking money out of a pension and re-investing them. However, investment options under a pension are now so wide-ranging that it is likely that most people would still be able to invest in their chosen area within their existing plan and avoid the tax charge on withdrawal.

For example, those who are really keen to invest in property could choose a property-based investment fund.

Future income options

Buying an annuity at a later age is likely (although not guaranteed) to result in a better conversion rate.

This is for two reasons:

  1. The client is older and has a shorter life expectancy
  2. The client is more likely to qualify for an enhanced rate for health reasons.

But it's not just annuity rates that might improve. Following the recent pension freedoms, it is expected that new products will become available which offer a blend of guarantees and investment growth.

Long term care

People living longer is generally a very positive thing, but increased longevity also means an increased likelihood that an individual may need some form of care in their old age, either in their home or via residential care.

Although the state will provide funding for this, the options available may not be the most appealing to the individual and their family. Pension savings may therefore be useful in providing more choices.

Currently any withdrawals to pay for care would be taxable in the same way as any other withdrawals. However there is a strong lobby, which I fully support, that believes tax breaks in these circumstances would be a strong motivation for people to keep saving.

In a nutshell

If your client needs income now and has no other funds available, then they have the option to access their pension. But if their income needs can be met using other capital assets, the pension is probably the very last thing that should be encashed.


 

Notes

1 I'm not talking ‘cashpoint cards’ here, but more like a 0 day notice building society account.


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