Your IndustryMay 7 2015

New ways to generate retirement income

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Taxing cash decisions

The only genuinely new way of generating a retirement income is the ability to take cash without limits. Retirees can take the whole pot at 55, or take ad hoc lump sums, most obviously through the new uncrystallised fund lump sum option.

Of course, most would continue to use the 25 per cent tax-free lump sum that becomes available when they hit 55, the rules around which have not changed for those going into drawdown. Uncrystallised fund lump sums would include a 25 per cent tax-free portion in each payment.

Those seeking to take cash need to be aware of the downsides, namely that they could run out of money if the withdrawal plan is not carefully managed and that they could face hefty tax charges. All new withdrawals will be hit with emergency taxes initially and are generally taxed as income.

But taking cash sensibly and utilising tax-free allowances enables clients to manage their tax bills by changing their income levels to accommodate other sources of income, some experts argue.

For example, Jamie Jenkins, head of pensions strategy at Standard Life, says a client who reaches state pension age and takes their state pension can tailor the income from their private pension to ensure they don’t fall into a higher tax bracket.

They can also use the £5,000 savings band, which Mr Jenkins points out can effectively give them £15,600 income tax-free. When the capital gains tax allowance of £11,100 is added to this Mr Jenkins says it becomes £27,700 tax-free per person.

That said, Mr Jenkins says it does require active management from year-to-year, and the cost that comes with this approach, particularly where a client has a range of assets as the tax treatment differs.

He says the tax implications of taking money out of the pension wrapper need to be carefully considered. Further details on how tax ramifications should be explored by advisers can be found in the next article in this guide.

Other savings

If a client wishes to, they can invest in other savings vehicles as an alternative to a pension.

It is hard to get away from the fact that the more an individual saves, the more retirement income they will have to work with, Alistair McQueen, head of policy and compliance business protection at Aviva, points out.

This fundamental principle is not changed if someone saves in a pension, a saving account, an Isa or other savings vehicle, he notes.

A pension requires a client to ‘lock away’ their money until they are at least 55. An attraction of a pension, however, in comparison to the other methods of saving is that the client benefit from the application of tax relief on all saving contributions.

Also, if they are saving in a workplace pension, Mr McQueen notes it is most likely they will also benefit from an additional contribution from their employer.

Of course, many will already have Isas when they hit retirement and the choice is simply whether to access this ahead of their pension.

The answer might depend on whether you wanted to pass on the pension fund in the wake of the abolition of death charges - if so, you’ll probably want to run down all your other sources of wealth and leave the pension untouched.

Property

One of those other sources of wealth - in fact the key wealth holding of many older savers - is property. Approximately one third of the UK’s property wealth is controlled by baby boomers, for example.

Homeowners could downsize to release a lump sum to invest or live from, while equity release is also becoming more attractive, according to David Trenner of Intelligent Pensions. He notes the market is better regulated and standards have been raised by the Equity Release Council.

For couples or individuals with no children, Mr Trenner says the old adage ‘you can’t take it with you’ is particularly pertinent when contemplating equity release, but he adds this product is even for those with children if they live into their 80s or even 90s.

Mr Trenner says those children will already be financially secure and less in need of an inheritance.

Additionally with pensions now being passed on tax free to the next generation in many cases, Mr Trenner says equity release can provide income and reduce the inheritance tax bill payable on the second death.

Ultimately one of the key appeals of equity release allows the client to release money from their property, while still living in it. A client can either borrow against the value of their home or sell all or part of it in exchange for a lump sum or a regular monthly income.

For many it will be an attractive option, according to Aviva’s Mr McQueen, especially at times of high property prices, but he adds it is a significant decision which should be taken with due care and consideration.

What is obvious from past complaints about this product is no assumptions should be made about what the client’s family were expecting to receive as an inheritance.

Mr McQueen says: “There will be costs associated with the equity release product; the client’s freedom to move house at a future date could be restricted; and eligibility for state benefits could be impacted.

“For many, their property could be their primary source of inheritance provision. Equity release will impact the amount of property inheritance that can be passed on to the next generation.”

Buy-to-let

And what about released money from the pension under new freedoms to expand the property portfolio and cash in on the buy-to-let boom, which could be a significant source of income?

While buy-to-let might be advisable with spare capital, Mr Trenner says you should not pay tax at 45 per cent to get a substantial sum of capital from your pension fund in order to invest in property.

In fact, the tax bill would be higher still: once you’ve taken the money out all income, including from the property, is taxed at the marginal rate you’re left on for the rest of that year; and stamp duty and capital gains tax on purchase and sale of the property need to be considered.

Mr Trenner adds: “A good tenant will provide secure income, but don’t forget the costs involved in acquisition and ongoing such as managing agent fees, landlord’s insurance, etc.

“No tenant can be guaranteed to stay for ever which can mean voids (periods where there is no tenant) and more agent fees.

“Property prices are currently buoyant, but if the market falls you could be stuck with reduced value property providing reduced rent. Property is generally illiquid, so you cannot get your capital if needed in a hurry.”