There are a couple of other factors you need to be aware of when it comes to retirement planning and mapping out your future finances, so I’ve included them here to round off this blog series.
Beware the Danger Zone
Let me just put in a warning here about the Danger Zone. I really need to come up with a less alarmist name for it, but I’m talking about the first few years of retirement before all your secured, that is, guaranteed, sources of income kick in.
These are the years where you will be drawing most heavily from invested assets and there’s potential for damage here. The damage is done by drawing down too heavily in the early years and by investing carelessly at the same time.
People often underestimate their spending in the early years of retirement. A combination of more free time, good health (hopefully) and disposable assets means that sometimes spending can be looser in these early years than perhaps it should be. Don’t throw all caution to the wind here, but be intentional, as ever…
Keep Taxation in Mind
You’ll need to keep your personal tax situation in mind as you navigate the danger zone, drawing down of DC pensions funds and maybe ISAs and GIAs for those early years and likely beyond that into the rest of your retirement.
No taxation issues with ISAs of course – you can take what you want when you want from those with no tax to pay. Beware the early access penalty on Lifetime ISAs if taking before age 60, though. DC pensions are taxable after the 25% tax free cash has been paid, but this can be useful in the early years of your retirement, where you may have some personal allowance going begging.
Think about it: You’ve stopped work so you have no earned income coming in. You may have rent which is taxable, but everyone has a personal allowance – currently £12,500 – that you can earn without paying any income tax. So if you have no earnings, you can draw from pensions to use up that personal allowance, in effect taking out more tax-free than you could otherwise.
If you have no earned income at all one year, you could draw £16,666 from your pension which would consist of £4,166 tax-free cash and the balance of £12,500 as taxable income which would all fall within your personal allowance and so is also tax-free.
Likewise if you have assets held outside pensions and ISAs and you make a gain, you could use the Capital Gains Allowance – £12,300 as of January 2021 – and sell some shares to realise this gain tax-free and spend that money. The system isn’t that hard to navigate, and you can definitely plan this yourself, but if you’re worried about getting it wrong, then seek professional advice.
Keep an Eye on the Lifetime Allowance
Finally, some of you may have issues with the Lifetime Allowance, or LTA. This is a maximum amount of benefits you can have from pensions without incurring a tax charge. The figure right now is £1,073,100 – weird I know – but it works like this. Every time you crystallise benefits from a pension, either a DB or a DC scheme, the benefits are measured against the LTA.
With a DB scheme, you multiply the pension by 20. So if you have a £10,000 per year pension kicking in at age 60, that would be £200,000 towards your LTA. If you then crystallised another £100,000 of DC pension fund, that would also go towards the LTA, making £300,000 in total.
The LTA goes up every year, and so generally we talk in terms of percentages of the LTA used. So your £200,000 of DB benefits would be 18.64% of the LTA used this year. Every time you crystallise funds, they are measured against the LTA and for many of us, we may have a tax charge to pay.
I’m fairly sanguine about the LTA charge with my clients. Usually it’s a tax on growth, and very often my clients who are going to fall foul of the LTA will have got to that point because of very generous employer benefits and so it isn’t ‘their’ money that’s being taxed.
Except of course it is, and so if we can, we need to plan around this. Unfortunately there’s no way to cover this in a podcast as there are too many moving parts at play, each one individual to the unique circumstances of the person we’re working with.
There are 13 benefit Crystallisation events when your pensions are tested against the LTA, including, randomly, you hitting age 75, or dying. If you think the LTA is going to be a problem for you, then please seek advice, as you really don’t want to get this wrong…
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