Ask an expert
helps readers pick the right strategies for making modest pension pots last
Minimising tax
I am 71. Until last year I had two private pensions. The fund from the first was £5,000, and the second, at the last valuation, was worth £50,000. In the summer of last year I took the proceeds from the smaller pension and paid the tax on that. I am now wondering what to do with the larger policy.
Am I able to take money from this pension in yearly amounts over the next five or so years? My reasoning is that, if I were able to do so, by taking (say) £10,000 per year I would pay tax only at the basic rate, whereas if I took more then I would pay tax at the higher rate.
Does this work? I don’t need to draw on the pension yet.
GH, VIA EMAIL
Tapping into your pension in small stages is a good option to minimise the impact of tax.
You are absolutely right that if you took all your pension in one go, you could end up paying higherrate tax, said Tom McPhail, head of retirement policy at Hargreaves Lansdown, the investment shop.
Depending on your income, taking out a large amount could push you into the higher-rate tax bracket.
This is because, after the tax-free lump sum, which is usually a quarter of your pot, or £12,500 in your case, any money you take out is added to your income in that year for income tax purposes.
“This means that you’d have around £37,500 added to your income in one year if you took it all in one go, which might well be enough to push you into paying higher-rate tax,” Mr McPhail said. But a better idea would be to tap into your pension pot in stages.
“Provided that your pension company can accommodate it, there is nothing to stop you tapping into your pension progressively in order to ensure you pay the minimum necessary tax.
“You also have the option of taking money from your pension and progressively recycling it into Isas. Any subsequent withdrawals from the Isa are entirely tax-free. However, it is important to note that, unlike with pensions, Isas are part of your estate for inheritance tax purposes.”
Whether or not you are able to take progressive withdrawals depends on the options your pension
A modest pot
I have a modest pension pot of £30,000 and am wondering what the most sensible plan would be for this money. I am a selfemployed piano teacher and have reached state pension age, but have deferred my state pension so that it will increase in value. I will not receive the new “single-tier” pension, £155 per week, since I was born in November 1952.
I realise I will always have to work as my pension income will be quite low and I have to be very careful with that small private pension pot.
What would be my best option for this money?
FT, VIA EMAIL
Working out how much income you actually need will be key to deciding what to do with your pension savings.
If you can afford to, adding more to your retirement fund is a sensible idea, as the tax relief will give your savings a significant boost. If you are a basic-rate taxpayer, the Government will add £20 to your pension for every £80 you invest.
With some careful investing and planning, you might end up with a higher income than you expect, according to Nero Patel, a financial planner at Canaccord Genuity Wealth Management.
Working towards a five-year goal based on how much income you imagine you will need, while deferring the state pension, is a good start.
You should obtain a forecast from the Department for Work and Pensions so that you know exactly how much state pension income you can currently expect, which will help you work out how much you need to save and how much you will add by deferring.
“Your private pension could secure an annuity today worth around £1,560 before tax each year, providing you with around £130 per month before tax,” Mr Patel said.
“You should obtain a forecast for your state pension, but I would estimate it to be worth around £135 a week.
“You would therefore have around £8,800 of annual income available at present if you were to decide to stop working in the near future.” But Mr Patel added: “If you are able to save a little each month into your private pension and continue to defer the state pension, you should be able to improve your retirement provision.
“Your state pension will increase by 10.4pc each year that you defer taking it and this could mean that it may increase to around £200 a week in around five years’ time, so it would significantly improve your finances.”
You should also review your pension and find out how it is invested, making sure that it matches up to your own plans and appetite for risk.
“If you do plan to work for as long as possible, it would be a good idea to invest for long-term growth,” Mr Patel said.
“If you do not have any other savings, your pension pot should be invested cautiously in order to protect it from market volatility.”
He also suggested that you seek advice on ensuring that the investments in the pension remain aligned to your personal risk tolerance and investment time frame.
“If you decide to add more money to the pot then you may feel comfortable with taking a little more investment risk, as monthly savings tend to benefit from something called ‘pound cost averaging’, which means that you end up buying more shares when markets fall. Over the long term, assuming that prices end up higher, this should mean you make more profit,” he added.