4 FLEXIBLE RETIREMENT INCOME OPTIONS
We explore the 4 new flexible pension income options you can exploit from April 2015. This will help you to start planning methods to release your valuable pension income if you want to start using this money.
- 4 flexible pension income options
- Managing your pension fund properly
- Get our free retirement income checklist
About flexible pensions
From April 2015 you will have a lot more freedom to access your pension funds, assuming you have reached age 55 by that date. You will be permitted to withdraw as little or as much as you want, without any restrictions. The only major downsides are that you will be taxed on 75% of your fund and that you need to make sure that your fund will last.
From April 2015 flexible retirement allows you 4 powerful ways to generate an income.
4 flexible pension income options
How flexible pensions income is taxed
When you decide to take your flexible pension income you are permitted to withdraw up to 25% of your fund tax-free. The rest is taxable as income.
This is no change to the current position.
I like to think of your pension fund as a cake shaped like a rectangle. The top part of your cake is iced differently to the rest of the cake, because it is better. It is tax-free. In our diagram the tax-free part is green, while the taxable bit is orange.
Option 1 – Tax-free cash only
You can take a horizontal slice of your cake so that you only withdraw the tax-free part. Here you can see that we have separated the tax-free cash element alone, and have withdrawn this. The rest of the fund will remain invested in your pension plan, and any future withdrawals will be taxable against your income.
Why take option 1?
You might need a lump sum to pay for a project or pay off debts. If you are still working you may decide that you do not need further income either because this is not needed, or because you do not want to pay additional income tax. Just remember that once you have taken your full tax-free cash that all future withdrawals will be taxable.
Option 2 – Tax-free cash plus a taxable income
You can take all of your tax-free cash and then withdraw an income from your plan. In our example you can see we have cut off the tax-free element of the cake and also a further taxable slice. The amount you take as taxable income is up to you, based on your needs and circumstances.
Why take option 2?
This option is much more like the traditional income route for pensions. Most people tend to take the maximum permitted tax-free lump sum. They then start to withdraw a taxable income to replace the income they have lost from employment.
The biggest issue you will face is to properly assess the income level you need, versus the income tax you will pay. As soon as you start to draw a taxable pension your annual allowance for pension contributions will reduce to £10,000 (£4,000 from April 2017).
Option 3 – Income only
If you do not need a lump sum now, but instead would prefer an income, you can instead make this income as tax-efficient as possible. You would do this by slicing the cake in a different direction, vertically this time. This means that the slice you remove is made up partly by a tax-free element, and partly by a taxable element. By being careful over the amount you withdraw, and by using us your tax-free cash, you can pay less income tax using this method.
Why take option 3?
This option allows you to take a flexible but tax-efficient income. This option is not appropriate for you if you want to withdraw the maximum tax-free lump sum, but could be better for you if you have enough cash savings elsewhere but instead want to be as efficient as possible with your income. As soon as you start to draw a taxable pension your annual allowance for pension contributions will reduce to £10,000 (£4,000 from April 2017).
Option 4 – Full withdrawal
This option allows you to withdraw your entire pension fund in one go. The tax-free part of your fund will be free of tax, and the rest will be taxable. The whole cake will be used up in this scenario, so you need to be sure that you will have enough future income to fund your lifestyle once the pension money has been spent.
Be aware that the taxable element will be added to your income for the tax year. If your fund is large you may and up paying a significant amount in income tax on this part of your pension fund. This could be anything from 20% to 45%.
Why take option 4?
I doubt that you will take option 4 unless your fund is not particularly large. You might be prepared to pay some income tax on the remaining fund if your total pension pot is less than £50,000. I suspect that the onerous tax payable for larger funds would mean that you would be more likely to stagger withdrawals over a number of years. As soon as you start to draw a taxable pension your annual allowance for pension contributions will reduce to £10,000 (£4,000 from April 2017).
Managing your pension fund properly
You need to be careful that your remaining pension fund is invested appropriately to ensure that your fund provides you with an income for as long as possible. See our Investment Management service.
What should you do next?
The easiest way to get started on maximising your retirement income is to download our free retirement income checklist. Just fill out the form below.
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About Dan Woodruff
Certified Financial Planner & Chartered Wealth Manager at Woodruff Financial Planning
Financial Planning helps you to navigate and anticipate significant life changes. I want to help you to ensure your money is managed wisely to give you the financial security that will fund the future and lifestyle that is important to you.