The new pension flexibility and greater inheritability of pension wealth could see conventional wisdom on retirement income planning flipped on its head. From April, it might pay to retain pension savings within the pension wrapper and take income from other investments first.
With tax-free allowances totalling £26,700 for income and capital gains each year, planning retirement income need not be taxing at all. But to get the most out of retirement savings, it takes the right mix of tax wrappers and advice about which wrappers to take income from, and which will provide the greatest inheritance for loved ones.
2015/16 Tax allowances
The personal income tax allowance is set to increase to £10,600 from April. In addition, it will be possible to take a further £5,000 savings income tax-free. There is also the annual capital gains tax exemption, which will stand at £11,100.
This makes a total of £26,700 of income and capital gains each year which can be taken tax-free by just making full use of the available exemptions. But if retirement income is being provided from the pension alone, then £16,100 worth of tax allowances could be missed. That is because the savings band begins to be removed once earned income – including pension income – exceeds the personal allowance.
Multi-investment retirement planning
To make the most of these allowances, it pays to have saved across a range of different investment tax wrappers after maxing out your pension and Isa. Each tax wrapper has its own particular tax characteristics. Having a combination of these can provide flexible tax-efficient income and estate planning solutions.
The ability to turn income up and down like a tap as required can be the key to opening up tax-efficient income in retirement. For example, stopping pension income for a particular tax year and replacing it by taking withdrawals from other investments can reduce the overall tax payable by using tax allowances.
Pensions
Remember it is only those with fully flexible DC pensions who will have this income freedom to manipulate the level of income each tax year, made up of any combination of income and/or tax-free cash.
It will not be possible to turn on and income from state pension, DB pensions, scheme pensions or conventional annuities like a tap.
Paying less tax on retirement income will mean the funds will last longer – assuming the same investment growth – leaving more wealth to pass on to loved ones.
Unlike most other assets, pension funds are rarely subject to inheritance tax. The new death benefit rules scrap the 55 per cent tax charge on drawdown lump sum death benefits. Each beneficiary will have exactly the same death benefit options from their inherited fund, allowing pension wealth to cascade down several generations while continuing to enjoy the tax freedoms that the pension wrapper will provide.
This could see a u-turn in strategy for anyone whose primary concern is maximising what can be passed on. The previous wisdom of stripping out funds and gifting the surplus income to minimise the impact of the 55 per cent tax charge has given way to retaining funds within the pension as a more tax-efficient solution.
