Retirement planning: reasons to keep calm and carry on

I’m excited to be a part of the new monthly Shares magazine team. Each month, I’ll look at what readers in the run up to retirement, and those already enjoying it should consider, with some planning pointers along the way. 

To say the last few years in pensions have seen plenty of changes is an understatement. The lifetime allowance has been abolished after years of tinkering with the maximum limit – although the less said about the rushed legislative process to get there, the better – and we’ve also seen proposals to bring pensions into people’s estate for inheritance tax (IHT).

What should be your top concern with your pension?

All this was big news for retirees with large pension pots, and particularly those who were planning to pass them on to future generations free of IHT. But the top concern for most people should still be making sure they have enough saved to fund a comfortable retirement for them, any spouse or partner, and potential long-term care costs.

Tax efficiency and using available allowances to keep more of the money you withdraw is still a sensible strategy. What I’m trying to say is, if you’ve already made retirement plans or are living them now, don’t panic.

The generous tax treatment of pensions on death was always an easy target. AJ Bell doesn’t believe applying IHT to pensions is a good way of achieving the government’s intended policy outcome – to encourage people to use their pension in retirement rather than leave it untouched as a way of passing on wealth. We have presented other methods that would raise equivalent amounts of tax revenue for HM Treasury without the complexity and the potential for double taxation for beneficiaries.

Even with the proposed IHT changes, most estates will not have any tax to pay. Married couples and civil partners will usually be able to pass on £1 million free of IHT on their own death. Everyone gets a nil rate band of £325,000 each, that can be transferred between spouses, and up to £175,000 is available for people leaving their property to a direct descendant. This additional ‘residence nil rate band’ is tapered down for estates over £2 million.

Although ISAs already form part of someone’s estate for IHT, spouses and civil partners can also inherit an extra ISA allowance. This means that not only can they inherit ISA assets on first death (free of IHT thanks to the spousal exemption), but the value of the ISA wrapper, too.

How should you order the drawing of money in retirement?

The pension proposals initially led to calls for people to switch from drawing on non-pension accounts like ISAs over to pensions right away.

What is best for you will depend on your personal circumstances and goals for your retirement. But instead of choosing one account type over the other, blending withdrawals from pension and non-pension accounts like ISAs and savings will generally make the most of the tax allowances on offer.

When accessing pensions, up to 25% can usually be taken tax-free, subject to an overall lump sum allowance of £268,275. Further withdrawals are then taxed as income at a pension saver’s marginal rate, meaning large income payments could tip people into a higher income tax bracket.

It will make sense for most people to take their pension tax-free cash before they reach age 75. Many people already do that and often have a clear plan for all or part of their tax-free lump sum when they retire. Anything that isn’t spent would form part of their estate for IHT, the same tax treatment as unused pension pots for deaths after 6 April 2027.

If the tax-free cash was instead kept within the pension and the pension holder died age 75 or over, their beneficiary (or beneficiaries) will pay income tax on what they take out later.

However, some have reacted to budget rumours and decided to withdraw their tax-free cash much earlier than this, perhaps without a plan beyond keeping it in a taxable savings account. This irreversible decision not only brings it into their estate now (before any IHT changes to pensions), but but means the money has been removed from a tax-free wrapper, so any income or gains from what isn’t spent will be caught by tax.

Withdrawals from ISAs are completely tax-free, so they might be an effective way to supplement retirement income, after any tax-free cash has been depleted. But for retirees concerned about IHT, taking pension income could also reduce the future value of their estate, help them spend more on themselves in retirement, and even mean they can help loved ones too, if they were confident of not outliving their retirement savings.

What action can you take today?

We still don’t have the final pensions and IHT rules, but here are three actions you can take now:

1. Review your pension nominations, across all your providers. Your pension is not covered by the wishes in your will, and someone you nominate will usually have the option to move anything they inherit from you into a pension in their own name, rather than just a lump sum option. This could be more tax efficient for them in future.
2. Speaking of wills, please check your will and make sure your wishes are up to date for your wider estate.
3. Finally, consider setting up a power of attorney so someone can manage your financial affairs if you’re not able to.