Over the course of your working life, you’ve probably spent decades contributing to a series of pensions. You may have final salary schemes from old employers, defined contributions schemes, or even a self-invested personal pension (SIPP).
So, when it comes to drawing an income, you might think you should immediately turn to your pensions. That’s what they are for – to support you when you’re no longer working!
However, drawing from your pensions first may not be the best course of action in every situation. Here’s why taking income from other sources might benefit you.
1. You can pass your pensions on in a tax-efficient way
Since the government introduced Pension Freedoms in 2015, retirees have been able to pass on pension wealth in a highly tax-efficient way. You can also leave your pension to beneficiaries of your choice – for example, children or even grandchildren.
If you die before the age of 75, your pension benefits are passed to your beneficiaries tax-free (provided the scheme is notified within two years). If you’re over the age of 75, the benefits are taxed at the beneficiary’s highest marginal rate of Income Tax.
Note that your beneficiary might pay extra tax if the amount you take from your pot before you die plus the amount you leave behind is more than the Lifetime Allowance (£1,073,000 in the 2020/21 tax year).
Compare this to holding significant investment assets, such as ISAs or shares. On your death, the value of all your investments forms part of your estate when it comes to calculating your Inheritance Tax liability.
In simple terms, if you’ve exhausted your pension pot when you die, but have significant investment assets, your estate could be liable for a 40% tax bill. If you’ve drawn your investments and left your pensions untouched, these can be paid tax-efficiently to your beneficiaries.
2. Savings continue to grow tax-efficiently
Another advantage of drawing from investments before pensions is that your pension stays invested within a very tax-favourable wrapper.
It will continue to build up tax-efficiently and you’ll benefit from the compound returns on all your contributions, tax relief, and growth your fund has generated.
3. You’re not limited by age
If you want to draw from your defined contribution pension, you’re restricted by age. As of the 2020/21 tax year this is age 55, but the government has recently announced it intends to raise the minimum age for drawing income under Pension Freedoms to 57 from April 2028.
If you want to retire before the age of 55 (or 57) then you won’t be able to access your defined contribution pension. You’ll need to consider drawing income from other sources.
This is another benefit of drawing from investments before income – you can do so at any time and you’re not limited by age. You can draw from other sources, leaving your pension invested tax-efficiently until such a time as you need to access the funds.
4. You’re not limited when it comes to making pension contributions
The pension Annual Allowance enables you to save up to £40,000 or 100% of your earnings into a pension each tax year and benefit from tax relief.
However, if you access your pension flexibly, you are subject to the Money Purchase Annual Allowance (MPAA) which reduces your Annual Allowance to just £4,000.
You generally don’t trigger the MPAA if:
- You take a cash lump sum and buy a lifetime annuity
- You put it into a flexi-access drawdown scheme and don’t take income from it
- You cash in pension pots worth less than £10,000.
Of course, if you don’t access your pension at all, you can continue to make contributions based on your earnings of more than £4,000 and benefit from the generous tax relief that pension contributions attract.
Get in touch
If you are approaching or at retirement and want to explore your options for drawing income, please get in touch. Please email firstname.lastname@example.org or call 01454 416 653 to find out how.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The value of your investment (and any income from them) can go down as well as up which would have an impact on the level of pension benefits available.
Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances. Levels, bases of and reliefs from taxation may change in subsequent Finance Acts.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.