Andy James, head of retirement planning at Towry illustrates the gains that can be achieved by making the right decisions about how you ‘spend’ your pension savings.
“Having spent all or most of your working life building up savings to fund your retirement, it is important to make the right decisions about how to use these savings to generate an income in retirement. If you make the right decisions you may be able to increase your income and afford to gift some money to your family too.
“Take the example of Stan. Stan, who is widowed with two adult children, has recently retired aged 65. Over his working life, he has built up retirement savings of £500,000. Stan takes no financial advice and instead buys the first available annuity he comes across, offering him £26,456 per year¹. Over Stan’s 20 year retirement, this income will likely halve in real terms², which would provide an annual equivalent of only £13,228 by the time he reaches 85. At Stan’s death aged 85, his annuity dies with him; he has nothing left in financial savings, and has left no money to leave to his children.
”If Stan had taken different decisions about how he would take his retirement income, he and his children would both have been better off.
“Consider the following example: again with Stan retiring at 65 with a £500,000 retirement fund.
- Stan takes a tax-free lump sum of 25%, the current tax free-sum allowed (£125,000)
- He gifts £25,000 of this lump sum to his children for their forthcoming weddings – a gift he can make tax-free via a potentially exempt transfer
- The remaining £100,000 is put into a combination of ISA investments and managed funds (using Stan’s full current ISA allowance of £11,880 per annum), and the managed funds pay his ISA subscriptions over a period of years.
- He gifts £3,000 a year to his two children – the maximum he can regularly give tax-free – and uses his other investments to help offset inflation, by withdrawing the sums needed from a combination of capital gains within his annual allowance made on his investment funds and tax-free withdrawals from his ISA.
“Despite taking this money from his retirement fund, Stan can still achieve a higher sustainable annual income of £30,600 through income drawdown (this is 8.16% per annum of his fund which is well within the current maximum he is allowed to take as set out by the Government Actuary’s Department (GAD) interest rate.)³
“In Stan’s case, taking an income using income drawdown has provided him with a greater annual amount compared to taking the first available annuity he found. At his death aged 85, he has gifted £85,000 tax-free to his children, and has still had a higher income each year in his retirement.
“Stan’s example is proof of how important it is to not rush into a decision at retirement. Everyone focuses on maximising the amount that they can save into their pension but it’s just as important to ensure that you take your income out in the most efficient and tax effective way. Making the wrong decision can cost you dear. A professional adviser will help you navigate through all these complexities to ensure that you make the choices that are right for you.”
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