According to research by pension provider Just Group, a growing number of retirees are not taking professional advice when accessing their retirement fund to draw an income. It found that 54% of those who accessed a defined contribution (DC) pension in 2020/21 did so without the help of a financial planner.
More alarmingly, it revealed that accessing pensions without professional help was on the rise. In 2019/20, half (50%) of pensioners accessed their pension pot without advice, and 48% did so in 2018/19.
If you have clients considering accessing their pension without a financial planner, discover why it could result in them paying more tax than necessary and could cause their pension to run dry – something that could put their lifestyle at serious risk.
1. They may pay too much Income Tax
As your client reaches retirement, they need to consider the most tax-efficient way of accessing their pension fund. Key to this is ensuring they draw their income in a way that reduces their exposure to Income Tax as much as possible.
In 2021/22, your client is likely to have a Personal Allowance of £12,570, which is the amount they can earn before being subject to 20% basic-rate Income Tax. If they take an income of more than £50,270, they will typically be liable to the higher-rate of Income Tax, which is 40%.
A financial planner could help your client explore other ways to draw an income, which could allow them to generate the amount they need without paying additional tax. This could be from ISAs or through their pension’s tax-free lump sum.
This might also be achieved through the use of an uncrystallised funds pension lump sum (UFPLS), which would allow your client to take their tax-free lump sum as an income.
If they do this, 25% of their income would typically be free of Income Tax, which could keep the taxable element of their income below their Personal Allowance, or within the 20% basic rate.
Your client may also achieve this using any ISAs that they have, as they’re typically not liable to Income Tax. This again could reduce the element of your client’s income that’s exposed to the tax.
2. Be careful of the Money Purchase Annual Allowance (MPAA)
The little-known Money Purchase Annual Allowance (MPAA) is triggered when your client flexibly accesses their pension. If triggered, the rule reduces the amount of tax relief your client receives on any contributions they make into another pension, perhaps because they carry on working part-time and pay into a workplace scheme.
The way it does this is by reducing your Annual Allowance, which is the amount of pension contributions you can make and benefit from tax relief.
In 2021/22, if the MPAA comes into effect, the allowance falls from the amount your client earns or £40,000 (whichever’s the lower) to just £4,000. As this could reduce the amount of contributions the government makes to your client’s pension through tax relief, it has the potential to reduce the size of their pension pot when they retire.
This could then affect the standard of living they can afford when they finish work.
3. They could end up paying emergency tax
This is a common tax trapdoor for those who access their pension without advice.
If your client takes an income from their pension, they may trigger the HM Revenue & Customs (HMRC) emergency “month one” tax code. This might be because they take an unusually high amount to kick-start their retirement, meaning HMRC then assumes this is the amount they will take every month and tax accordingly.
If your client is charged at this emergency tax rate, they will need to fill in a tax return or wait until the end of your tax year to get a rebate.
4. Consider the Inheritance Tax benefits of pensions
As pensions typically fall outside of an estate for Inheritance Tax (IHT) purposes, they can be an excellent way of reducing exposure to the tax. This means that if your client uses savings and other investments that may be subject to IHT before drawing on their pension, they might reduce their exposure to the tax.
As IHT is typically charged at 40%, passing wealth to loved ones using pensions could help your client leave significantly more money to beneficiaries.
5. Your client’s pension could run out
According to Professional Adviser, data from the Financial Conduct Authority (FCA) shows that 43% of retirees took an income of more than 8% from their pension pot. At this level, they are at serious risk of their retirement fund running dry and causing major financial headaches in the future.
Working with a financial planner could help your client understand what level of income they could take to ensure it does not run out. Using sophisticated income modelling software, a planner could provide your clients with peace of mind that the amount they’re taking as an income will sustain their lifestyle for as long as needed.
Get in touch
If you would like to discuss how we may help a client who is looking to access their pension pot, please email hello@ardentuk.com or call 01904 655 330. As award-winning specialists in financial planning, you’ll have peace of mind that we will provide your clients with the very best advice and service.
Not only could this benefit your client, but it could also help enhance your business’s reputation.
Please note
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
A pension is a long-term investment. The fund value may fluctuate and can go down, 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, tax legislation and regulation, which are subject to change in the future.
