Most pension experts would say that spending in retirement – decumulation – should follow a policy of ‘pensions last’, so why is it that the majority of our clients so often want to spend ‘pensions first’?
It’s partly our fault. Pension plans are set up with a single ‘retirement date’ and the focus is all around that timescale. If we tell people for 20 years that they can have their pension at age 60, then when they get to age 60 they naturally think they should have it.
People are often used to having ‘rainy day’ money that they try not to touch. This won’t be their pension – that was unavailable – it is more likely to be a savings account such as an ISA. They have spent years building it up and have a mindset which says “don’t touch this”.
Most normal people – that is, not pensions geeks – are more familiar with cash-based savings plans and are less likely to be engaged with their pension. After all it’s been untouchable for years, and probably at the back of their minds when it comes to everyday finances.
It is no wonder therefore that one of the most common issues we find ourselves dealing with is where clients want to take money from their pension but have other assets which it would be more tax-efficient to cash in.
Frank and Fay were in such a situation when we met them following the retirement of their previous financial adviser. They had been withdrawing £50,000 per year from their collective pension funds for the last six years, based on a cashflow model which predicated a 35% reduction in income withdrawals when Frank reached age 70. This was now just three years away. Our problems were:
- How to manage the step down in income – in common with many people, Frank had quite happily believed that he would not want to spend as much when he reached age 75. Now that he is a relatively healthy 72-year-old, with a wife who is also fit and active, this is a much less appealing prospect.
2. How to persuade Frank to use his other assets and stop the withdrawals from his pension fund to improve tax-efficiency and preserve the pension fund for later.
We took a three-pronged approach.
Tactic 1 – Income tax
First, and to be honest probably the most effective tactic, was to calculate the income tax he was paying on his pension withdrawals. This amounted to around £7,000 per annum. Frank had not considered this and was quite horrified by this amount, particularly when we told him that withdrawals from his ISA would be tax-free.
Tactic 2 – Access
Convince him that their pension could be the ‘rainy day fund’. Frank and Fay had recently had to replace the flooring for most of the ground floor in their house, due to a flood. The insurance had paid out but they wanted to take the chance to upgrade the décor at the same time and had used some of Frank’s ISA savings to pay for it. The ability to do this was an important issue for them.
Using the ISA for this purpose made sense however only because they’d had to use the money. Meanwhile they had been paying income tax on the income that they definitely needed as opposed to the money they might need.
The problem was that they didn’t realise they could have accessed the extra money from their pension in time to pay their bills; they believed it was still locked away and should only be used to provide an income. Once we reminded them that they could have a lump sum from Frank’s drawdown plan, within 2-3 weeks of requesting it, they were reassured. Yes, future withdrawals would be subject to tax but only if and when they were required.
Tactic 3 – Death benefits
Frank and Fay have two grown up daughters and three grandchildren. Despite this, again not uncommonly, Frank’s plan was set up to pay death benefits only to Fay as he was naturally concerned that she should be provided for if he pre-deceased her. We showed him that he could also nominate his daughters and that this would allow Fay to give up her rights to them if she chose to and that, any benefits passed on would then – unlike the ISA – be outside of his estate.
Finally, we used a cashflow model to consolidate all of this into a single picture which Frank and Fay could follow and understand. This also showed them how the investment growth of their pension could help them to maintain their current overall income for around eight years longer rather than reducing it at 75, as they had originally planned.
As Frank was already using his personal allowance from other income he stopped taking income from his pension and got in touch with his bank to start regular withdrawals from his ISA.
Fiona Tait is technical director at Intelligent Pensions