In our bi-weekly series, readers can email in with any question about their finances to be answered by our expert, Charlotte Ransom. Charlotte has 30 years’ experience working in financial services and wealth planning, including ten years as a partner at Goldman Sachs. She co-founded Netwealth, which specialises in low-cost investing and financial planning advice. If you have a question for her, email us at money@inews.co.uk.
Question: I am 68, working part time, and will retire fully when I reach 70. With £820,000 in pension savings, I would say I have enough for a comfortable retirement, but I am concerned about the taxes I might encounter in later life – especially taxes associated with pension drawdown and the significant implications of inheritance tax. How should I start planning for my finances when I reach 70?
Answer: As you are retiring in a couple of years, it is sensible to assess how comfortable your retirement could be and what taxes you might have to pay. It’s better to find out what actions you might have to take, rather than leave it to the last minute – and you could have more to spend in retirement as a result.
Let’s take a closer look as to whether £820,000 in pension savings is enough for a comfortable retirement. The latest figures produced by The Pensions and Lifetime Savings Association (PLSA) in February take the sharp rise in the cost of living into account and suggest that a single person would need £43,100 a year for a comfortable retirement, with a higher figure for a couple. In your specific example, we don’t know whether you have a partner, so we’ll evaluate based on you as an individual.
If we assume investment growth in the next couple of years of five per cent (and no further contributions), your pot could grow to around £900,000 while you live off your state pension and part-time income until you reach 70. Given the fact that people are generally living longer, a 20-year retirement is then an appropriate timeframe to consider when assessing how comfortable a retirement you could have and how much you could potentially leave behind.
If we use the PLSA’s suggestion of £43,100 a year to achieve a comfortable retirement (roughly £3,600 a month) we can calculate that your £900,000, with a five per cent return each year, would produce around £45,000 a year – and you would still have all your capital left by the time you reach 90 – if you are thinking of the next generation, you would have a very valuable pot to pass on in this example. However, please bear in mind that this calculation doesn’t include income tax, and there is always the impact of inflation to consider in terms of the value of future income.
Let’s not forget to include the state pension in terms of your total annual income, with the full state pension being around £11,500 a year from April and, we could say the state pension would effectively cover your income tax liability, depending on how much income you decide to give yourself. Bear in mind that when your income reaches £50,271 you will pay 40 per cent tax on your full income, which includes income from your personal and state pensions. Below this, the rate is 20 per cent – with the customary tax free allowance (£12,570) for both.
Another important aspect to remember is that you are also entitled to take 25 per cent of your pension pot tax free. You can take this as a lump sum or use it to boost your income over a number of years. If you wish to continue to make the most of this money, you could then drip-feed it into an ISA, and potentially achieve more investment growth over time. A quarter of £900,000 is £225,000 and this is a considerable sum to invest again, or to use as you wish. Alternatively, you may choose not to take the 25 per cent tax free lump sum and to leave it in your pension if you wish to make the most of inheritance tax (IHT) regulations.
While IHT is typically paid if your estate is worth more than £325,000 when you die, a pension can be exempt if you choose a beneficiary or beneficiaries – they can be relatives or others you would like to pass your wealth on to. If the pension holder dies before age 75, the recipient can draw income tax free. After that, the recipient will then only pay tax on this inheritance at their own marginal rate of income tax. You can also lessen your overall IHT bill while you are alive by gifting sums to loved ones – if they are above the free gifting threshold, they still become fully tax exempt if you live for seven years after you make the gift.
Importantly, there are also other crucial considerations when aiming to boost and maintain an investment pot. In retirement, two of the biggest factors which can affect how much you have to live on and to leave behind, are the level of investment risk you choose to take, and how much you pay in fees.
Taking more risk will typically give you the potential for higher returns over time and can be a sensible approach if you have a longer timeframe, such as 20 years. As retirement goes on, you may look to reduce the risk you take, accepting the likelihood of lower returns; however, this will depend on several factors including aspects such as your comfort with the nature of investment risk, the size of your pot, your target income and whether you intend to pass money on.
High fees when investing (including in a pension or an ISA) is one of the factors I highlight most in this column. It is still the most underrated risk to a positive long-term investment outcome. As an illustration, we can show that the difference between paying one per cent in all-in fees compared to two per cent on a pot of £900,000 – with an annual return of five per cent over 20 years – is £1.97m vs £1.62m.
This example highlights a compelling and often widely ignored principle: seemingly small differences in charges can produce a dreadfully disproportionate result, especially over long timeframes. It is very important to remember that you have control in terms of what you pay in fees, so make sure you know exactly how much you are being charged in total and take action if you are not happy.
How you structure your withdrawals when in retirement will be a key part of your strategy to maximise income and minimise the tax you have to pay, and therefore warrants an individualised approach. Such a key life stage is important in the context of understanding your future needs and ensuring you take the right preparatory steps.
It might be worth seeking a professional adviser to help discuss your individual needs and help unpick the various allowances (including IHT), tax implications and ongoing changes to regulations – this does not need to be in the form of ongoing advice, and can be a one-off piece of advice to help you navigate this next step.
In summary, it’s important to get your retirement pot in as good a shape as you can. In the two years you have before you retire, you can make a proper assessment of your likely future needs and ensure that your pot is invested both efficiently and appropriately to make the most of your upcoming retirement years and to fit with your plans. This is the best route to enjoying the comfortable retirement you seek and also to have the opportunity to pass on wealth to future generations if you so choose.
