New pension flexibility - Practical application #1

Since the budget in March 2014, there has been much commentary over the revisions to pension flexibility which come into effect in April 2015, but considerably less on the practical ways that the new rules could help bring practical solutions to life.  Below is a real life situation that illustrates how these changes can work in practice.

I recently met with a couple who were both approaching 60. They would ideally like to retire now, but are realistically planning to retire at age 65, at which time they will both receive a full state pension that will provide them with a joint income of around £15,000 per annum. Their only other retirement provision is a personal pension held by the husband, valued at around £135,000. He could take the benefits now and would be entitled to 25% of this fund as a tax free lump sum - around £33,750 – leaving £101,250 to consider other retirement options.

One option could be to buy an annuity and on the assumption that this is purchased on a joint basis, the income remains level (i.e. not increasing) and the clients are in good health, this could provide a guaranteed lifetime income of approximately £4,800 per annum*, based upon the best rate currently available. Although the payment is guaranteed, it will not, of course, keep pace with inflation. *(Source: IRESS, The Exchange Portal, 3/10/2014)

Alternatively, our clients could opt to move into a drawdown arrangement, whereby the fund remains invested, but an income is secured from it. In this format the residual fund (after the tax free sum has been taken) could provide a regular income in the region of £7,745* per annum. *(Source: Hornbuckle Mitchell website, GAD calculator).  This figure could be uplifted if they decide against taking all or part of the tax free lump sum, but stand alone this won’t provide them with anywhere near enough to retire now as they require at least £1,500 per month net to do so.

When the new pension flexibility rules come into effect in April 2015 this position could change significantly, as they can have full access to the entire pension fund. The new rules would now allow them to retire at age 60, by withdrawing the £18,000 net that they require each year for the next five years. This works as follows:

Assuming the husband retains the full £10,000 annual personal tax allowance, by using the tax free cash to provide £6,750 and taking a further (taxable) £11,563 directly from the pension fund, meaning that he could have a resultant net income of £18,000 per annum and incur an Income Tax liability of just £313.

Clearly, by adopting this approach the pension fund will be depleted over the five years until the clients’ state pensions kick in and assuming no investment growth whatsoever the fund could be worth just £43,435, but as their state pensions will have increased by the rate of inflation (RPI) over this period, at age 65 the pension fund will have to generate considerably less than before and could indeed be taken at any level from there on.

If they drew the balance of their pension fund to bridge the gap between their state pensions and the required £18,000 per annum, the residual fund could feasibly last them beyond age 80.

For these clients the ability to enjoy an extra five years of retirement, starting almost immediately, was hugely attractive and something they could not previously have considered under the existing pension rules. They want their retirement income to be higher in the earlier retirement years whilst they are more healthy and active and accept a less outgoing lifestyle in later life, so this solution is ideal for them.

The additional flexibility available next year means that this couple now have choices available to them that they could not previously consider. I expect that many more people like them will choose to take a similar approach, rather than blowing their pension funds on a Lamborghini, as so many sceptics initially thought would be the case.

Of course, the new rules also mean that the option of a one-off supercar purchase still remains, if they want it!

David Squire, Partner

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