Flexible access pensions (flexi-access) are changing the way people think about traditional pension schemes. Not only can they offer a wide range of financial benefits, but they can also give you much more personal control over your funds allowing you to feel confident, and secure about the future.
So, what exactly are flexible access funds? And what are the benefits of transitioning to one when looking into retirement?
This short article will be a helpful guide in helping you understand exactly what flexible access pensions are, and why you should be using them.
Avoiding a heavy tax bill
In 2015, a surprising new set of rules came out which changed the world of pension planning.
It stated that everyone over the age of 55 who was legally allowed to start making pension withdrawals would be able to draw out any amount of their pension funds at any given time.
Perhaps what they were hoping for was that everybody with substantial pension funds would just draw the whole thing out in one lump sum.
It would certainly have been a nice payday for the government. They could cash in on the huge amount of revenue generated from taxing these pensions as income.
However, what actually happened was that a lot of people started steering towards financial advisers to find ways of taking out their money in a much more sensible manner. By doing so they could avoid the heavy tax on large withdrawals, but also use the benefits associated with these new rules. It created a win-win.
So, how does this work?
It's like a taxable bank account
Essentially, if you are over the age of 55, you can start treating your pension like a taxable bank account. If you want to take money out, you can. You just pay the tax on what you have withdrawn. Nice and simple, right?
It's as if you are paying yourself a salary, say £20,000 per year, but without paying national insurance tax. You just pay your standard basic rate tax. This alone is an attractive prospect for those of us looking to move into retirement as it offers a lot more flexibility when it comes to managing your post-career income.
And on the topic of tax, it can get even better because one of the big benefits when looking at flexible access is the tax-efficient drawdown.
Let’s take a look at what this means.
Tax-efficient drawdown – making every penny count
Anyone looking at making withdrawals from their pensions will know that you can withdraw up to 25% tax-free cash. Of course, you can take this out as one lump sum which some people do.
Though, many people don’t actually need all that cash. If you have paid off your mortgage(s) and don’t have any substantial debt, that 25% can be a lot more useful than just sitting in your bank account.
As an example only, lets say you put 25% of a decent pension into your income and take £20,000 per annum. In this case, only around £15,000 of the £20,000 is taxable, and you only pay tax on what’s over the personal allowance which is £12,500. So you only actually end up paying a 20% tax on £2,500.
So, on a £20,000 per year pension, you have £19,500 after tax.
This is a hugely attractive prospect to anyone and is one of the great benefits of a flexible access pension that isn’t possible on an annuity. Annuities do not allow you to use any tax-free allowance to create tax-free income, on an ongoing basis in the same way.
It's important to understand this and begin to look at making a shift if you are in an older pension.
Apart from saving a great deal and generating a tax-efficient drawdown, flexible access pensions offer other great personal benefits too. One of the most significant being the fantastic death benefits they offer.
Death benefits – looking after your family
Flexible access plans are great for generational planning because the money can be passed down, in many cases, without inheritance tax.
For example, if you died before the age of 75, with a flexible access pension your dependents don’t pay inheritance tax. This is great. It means they can access the entire fund for free if you’ve got less than the lifetime allowance. This is for your spouse, kids or anyone else you want to leave money to.
Older pensions are far more rigid. Should you die in the early stages of an annuity you may find that a lot of your pension will be absorbed by the provider. For example, a £100,000 pension paying out £3,000 a year with a 10-year guarantee may pay out the 10 years (£30,000) if you were to die early. However, the remaining funds will go back into the pension, not to the family.
Nowadays, nobody seriously considers annuity because they all want death benefits for their beneficiaries. Normally annuities are set up at only 50% to the spouses, which doesn’t make much sense when you realise you can have all the remaining funds passed over to you with a flexible access pension.
So, how does one get a flexible pension?
Speak to an adviser
Many people will read online about these new benefits but find they are unable to use them as their old pension is unable to facilitate flexi-access which is why more and more people are using good independent advisers to help them make the switch.
But a good adviser can also make sure that the funds are being managed well and that you don’t take any unnecessary risk by trying to cut corners.
Let me give you an example.
Don’t leave yourself exposed to the stock market
One the cheapest routes out there to manage your pension funds would be to buy a UK market tracker fund. This will save you about 0.5% a year but it’s a risky game and can leave you very exposed to the volatility of the stock market.
So, I’d always recommend you go to a good adviser and build a strong portfolio that can mitigate the risks through effective diversification and asset class management. We talked all about this in a recent blog, which is a great resource for those looking to read more on the subject.
You get to decide
In summary, moving to a flexible access pension is possibly a good idea. It provides a great number of financial benefits as well as gives you a real sense of control over what happens to your funds should the worst happen.
But also, flexible access gives you back control of your own money. You get to decide how much to withdraw and how much to keep in. If your portfolio performed well last year, great! Treat yourself to a nice bonus and enjoy your retirement.
Ultimately you get to decide what to do and as your income requirements shift and change with age, you can adjust your budget to fit in a controlled personalised way.
I hope this has been useful and if you do want to find out more feel free to get in touch by emailing me at firstname.lastname@example.org
More to come next week.
The views expressed in this article are those of the author and do not constitute financial advice. Applewood Independent Ltd is authorised and regulated by the Financial Conduct Authority. For financial advice designed for you and your specific circumstances, please contact the author using the contact details provided in this article, or alternatively contact the Applewood Independent Ltd office on 01270 626555.
Accessing pension benefits early may impact on levels of retirement income and your entitlement to certain means tested benefits.
Accessing pension benefits is not suitable for everyone. You should seek advice to understand your options at retirement.
The Financial conduct authority does not regulate taxation advice
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. Pension income could also be affected by interest rates at the time benefits are taken.
The tax treatment of pensions in general and tax implications of pension withdrawals will be based on individual circumstances, tax legislation and regulation, which are subject to change in the future.