Access in haste repent at leisure

Would you want to access your pension early? Kay Ingram, director individual savings and investments, LEBC Group, considers your options

Access in haste repent at leisure

Some months into the pensions freedoms which have enabled individuals more liberal access to money purchase pension funds from age 55, it seems timely to consider why one might want – or not want – to do so.

Gaining access early will carry long-term implications for the sustainability of income which most people will be relying on to pay their bills in what could be a long retirement.

It also comes with many tax disadvantages, compared to retaining the pension investment wrapper until retirement starts and this aspect is often obscured by the access to 25% of the fund on a tax free basis. This appears to be very attractive but could result in much more tax being paid on the money withdrawn compared to keeping it invested in the pension fund for longer.

Tax advantages

To appreciate this it is important to understand the extent to which pension savings are tax privileged while they remain in the pension wrapper and how they are taxed following withdrawal.

Funds of up to £1.25m per person enjoy the following tax advantages while in the pension wrapper:

  • They pay no capital gains tax on growth in the fund
  • They only pay 10% tax on dividends
  • They never form part of the estate of a deceased person for inheritance tax purposes
  • If death occurs before age 75 the remaining fund not spent, can be left tax free to any person(s) or a charity until the fund is exhausted
  • On death after age 75 the fund can be left to nominees who will only pay tax on the fund at their marginal income tax rate, as and when they draw income out. The fund will continue to roll up with all of the tax privileges outlined above. If they die without spending all of the fund they can leave it to their successor who will pay no tax on funds passed on death before age 75 and only marginal income tax on death after age 75.

Given these tax advantages and for all but the very wealthy, preserving pension funds for as long as possible before accessing them can be highly beneficial in the long run.

Unlocking pensions

So why are some people keen to unlock their pension savings early even when they don’t have a specific need for the cash or income?

Pension funds rely on investment returns to generate income and at a time when markets are volatile and underlying capital values are likely to show sharp gains and losses in the short term, some may worry about the security of their funds.

This may lead them to withdraw funds not because they need the money to spend on essentials now but because they prefer to take only those investment risks which are familiar, such as cash savings or residential property, and so prematurely withdraw funds from the tax privileged wrapper to exercise more investment control. In practice lower risk funds are usually available within the pension wrapper and changing to a lower risk fund is easy to achieve and often at no or little cost.

Others may see withdrawal of funds as a short-term fix to short-term indebtedness or simply wish to “live for today”.

Whatever the motivation, unless pension savings are so small as to be insignificant or they have so much other wealth that it really does not matter, those who access their funds in haste might live to repent it at their leisure.

Basic rules

To avoid this fate when accessing your pensions you need to observe a few basic rules:

  1. Have a clear understanding of how much early access will impact on your longer term income needs
  2. Have a clear purpose in accessing your funds early; don’t just take the funds out because you can or act because you have reached the age at which you originally intended to retire – you can change this if you don’t need the income now
  3. Understand how much tax you will pay on the withdrawal of funds before you commit to taking them
  4. Consider withdrawing income little and often as this can reduce the tax payable significantly and so make the funds last longer
  5. Don’t act until you have explored all the options and feel that you understand the pros and cons of each.

Free guidance is available from Pension Wise, a Government inspired initiative which can offer guidance on pensions to the over 55s.

For advice which you can act upon and for which the adviser will take full responsibility backed up by consumer redress and a compensation scheme you may consult an independent financial planner regulated by the FCA. They will charge you for their advice but will usually offer a free introductory chat to explore their advice options and costs before you commit to using their service.

While you may exercise the option of early access to some pension plans without the requirement for you to be advised, many pensions which contain valuable guarantees can only be accessed with advice. This is designed to help prevent the loss of worthwhile guarantees which may not be easy to assess without professional help.

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