Iam 55 and have accrued pension funds worth around £800,000. I have been told by an IFA friend that I should consider taking the benefits of my pension now, including maximum tax-free cash and maximum income, in order to reduce my fund to a minimum by the time I am 75, because any remaining funds on my death after 75 will be lost. Is this a sensible thing to do?
This is a very topical issue since a U-turn in the rules has prevented any remaining funds on death after 75 to be passed on to dependants’ pensions, as was originally expected to be allowed.
The things to consider when deciding what to do with your pension fund are the same as they have always been. Have you been saving all your working life to provide yourself with a good, stable income in retirement? If so, then you should think very carefully before you risk depleting your fund to the extent that it will not provide you with an adequate income in your later years.
I am assuming for the moment that you do not need any tax-free cash or income from this pension at present. I am also assuming that your adviser friend is suggesting you reinvest the cash and income in alternative investments that can be passed on to your dependants at the time of your death, albeit after an income tax charge of up to 40 per cent on the income withdrawn and a 40 per cent inheritance tax charge. Can you be assured that these options will provide you with an adequate, guaranteed level of income for the rest of your life if you live to 100?
Annuity purchase can actually be fairly good value at 75 and there are guarantees that can be purchased to ensure that your entire remaining funds are not lost at the time of your death. Do you have a spouse to consider? Will he or she be in a good financial situation at the time of your death after 75 if your pension at that time has been depleted?
You should also look at the charges and tax rules surrounding these alternative products. I would expect there to be some initial charges and that the tax rules will not be as favourable as investments within pensions. Over a period of 20 years, this can make quite a difference to the size of your investments.
When you go into full drawdown and take your maximum tax-free cash, you have immediately changed the tax situation for the worse in the event of your death in the near future. You go from being able to pass on your full pension fund free of all taxes to having the tax-free cash in your estate, so subject to IHT, and the remainder of your fund subject to a 35 per cent tax charge, assuming it is taken as a lump sum.
With all the changes that have affected pensions over the last few years, are there more changes to come? As it is 20 years until you reach 75, it is possible that by that time there may be an option that would suit your wish to pass on some or all of your remaining fund to your beneficiaries upon death. My point here is that no one knows what the rules will be in the future and if they change to your benefit, you may regret depleting your fund in favour of less tax-advantageous investments that are held within your estate.
I would suggest that a balance needs to be found in this scenario and that phasing benefits, so that you only take part of your fund into drawdown at a time, may be an option worth considering at some point.
Phasing benefits will keep the majority (the unvested part) of your fund outside your estate for IHT purposes, yet will enable you to reduce the size of your fund slowly over the coming years if you feel you have more than you want or need to use for purely pension income in future.
There are certainly people who should be doing as your adviser friend suggests, especially if they are not married and/or have a pension fund and other wealth exceeding their needs. However, this is not blanket advice and personal circumstances should dictate whether this is something you would be well advised to do.
Emma Duncan is a director of Thameside