METEREveryone dreams of being able to spend their retirement years enjoying themselves, without having to worry about money. Maybe you want to buy a villa in the south of France, take that history course you never had time for, or grow your own garden.
Whatever your aspiration, while it’s important to make sure you have enough saved for your pension, retirement planning is also crucial. We asked some financial experts what to do and what not to do.
One of the main challenges is making your money last into retirement. The Pensions and Lifetime Savings Association estimates that a single person needs £31,300 a year after tax to live a moderate lifestyle in retirement. This allows for two weeks’ foreign holidays each year, food and drink. Go out regularly and spend £55 a week on groceries. Couples who can share the cost need £43,100 between them.
Experts say many people make the mistake of “de-risking” their investments too early, moving their money out of stocks and shares into assets such as government bonds, which are considered safer but don’t offer the same potential returns.
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If you have a defined contribution pension at work, where the amount you receive depends on how much you have saved and how your investments have performed, de-risking usually happens automatically about 15 years before your retirement date. If you don’t want your investments de-risked, you can contact the pension scheme and ask to have your money moved to a different fund. You can also set a later target retirement date to ensure your money stays in a growth fund for longer.
Research firm Isio analysed the performance of 14 pension funds in their growth phase and found they generated a return of 6.9 per cent a year in the three years to April. This fell to an average of 2.6 per cent a year for pension funds that had been unprotected. This means a saver with £300,000 could have £597,000 after ten years if their money had been in a growth fund – £208,000 more than if it had been in an unprotected fund.
DON’T take your tax-free lump sum too soon
Investment platform Hargreaves Lansdown said 4 per cent of its clients withdrew some or all of their tax-free cash within 30 days of turning 55, the age at which you can normally access your pension pot (set to rise to 57 from April 2028). You can withdraw 25 per cent of your pension tax-free, up to a limit of £268,275, and will normally pay income tax on the remainder.
Taking all your tax-free money out at once may make sense if you plan to pay off your mortgage or need it for a major purchase, but it doesn’t make sense to leave the money in your bank account. “It’s more efficient to leave the money in a pension fund where it can continue to grow tax-free and withdraw it when the need arises,” said Gianpaolo Mantini of wealth manager Saltus.
If a 65-year-old with a £400,000 pension pot decides to withdraw all the money tax-free in one go, they can withdraw £100,000. If they instead withdraw the money in a series of lump sums, it can keep growing, and 25 per cent of each withdrawal would be tax-free. If they withdraw their money over a 10-year period, they can withdraw £125,779 tax-free in total, Mantini said. He assumed that he would withdraw 10 per cent of his pot in the first year (£40,000 in total, of which £10,000 is tax-free) and that the remaining pot would grow at a rate of 5 per cent a year after fees. Each year they could increase their withdrawal by 5 per cent (withdrawing £42,000 in the second year, for example, of which £10,500 would be tax-free).
Use other savings first
Leaving an inheritance to loved ones is important to many people. Pensions are a tax-efficient way to pass on wealth and advisers often recommend using other sources of income, such as savings and investments, before using your pension.
Normally, a defined contribution pension fund does not count towards the value of your estate for inheritance tax purposes. If you die before age 75, withdrawals made by your beneficiaries through drawdowns will be tax-free. It is possible that this tax exemption will be removed under the new government, but nothing has been said yet.
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If you die after age 75, your beneficiary will normally pay income tax on any withdrawal and will lose the option to receive a 25 percent tax-free lump sum.
Carla Morris, of wealth management firm RBC Brewin Dolphin, said some clients withdraw their cash tax-free and then invest it in assets that are exempt from inheritance tax, such as unquoted stocks and shares. “These investments are high risk and would not be suitable for everyone,” Morris said. “But one of the advantages of this compared to gifting the money is that the assets remain in your name and you can get your money back if there are unforeseen costs to cover later in life.”
If your tax-free lump sum isn’t large, you can add it to an investment ISA over a number of years (the limit is £20,000 a year) and then benefit from tax-free growth and withdrawals.
Continue topping up your pension
Just because you’ve stopped working doesn’t mean you have to stop saving. You can put £3,600 a year into a tax-deductible pension even if you don’t earn any income. If you’re under 75, your pension contributions benefit from basic tax relief. This means it would cost a non-working person only £2,880 to add the maximum £3,600 to their pot.
“It may not seem like a lot of money, but if you have excess cash that could go further, it makes sense to invest it sensibly through a tax-free wrapper. Moving money into a pension can also reduce your inheritance tax liability,” said Henrietta Grimston of wealth management firm Evelyn Partners.
If you’re still working, the maximum you can save annually into a tax-free pension is £60,000 or 100 per cent of your salary, whichever is lower. If you’ve started taking withdrawals other than your tax-free lump sum, then you can’t normally save more than £10,000 a year into your pension.
Saving for a pension can be very tax-efficient. If you continue to earn income from work and claim your state pension, you will likely have to pay income tax. If you were to save your salary for a pension, you would benefit from tax relief and could withdraw 25 per cent of your pension pot tax-free. If you had other savings in a tax-free ISA, it may make more sense to spend them first, rather than paying income tax.
Don’t spend too little
After 40 years of accumulating wealth, it can feel strange, even scary, to start using it. Not only should you spend it, but it might be a good idea to make a plan to spend more at the beginning of retirement, when you want to enjoy your newfound freedom. Then, you can spend less in the middle and later, when you need to cover health care costs. This is known as the “smile” model.
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However, David Bird of Now Pensions believes this is unlikely to work for everyone. “People want an inflation-linked income, to be able to leave an inheritance and save money for a rainy day. The reality is that not everyone can afford this. If you have to compromise, remember that you haven’t saved your pension for the next generation or to give it to a long-term care provider. You have to enjoy it.”
Instead of setting aside money for an inheritance or to cover health care expenses, you could plan to spend more early in retirement and gradually reduce your spending as you get older. Bird calls this the “smirk” approach.
This means you plan to rely on your state pension at the end of your life. Your local council will usually contribute to the costs of your care if you have savings of less than £23,250 and are not a homeowner.
John Hitchin keeps busy in retirement spending time with friends and his racehorses.
GATHER
“I have property income, I don’t need to touch my private pension”
John Hitchin keeps busy in retirement spending time with friends and his racehorses and playing the organ at his local church.
“I’ve never been married and I don’t have any children, so I don’t have that expense or that worry,” said Hitchin, 71. “I don’t plan on going to a care home, but I have money if I need it.”
Hitchin, from Dillington in Cambridgeshire, stopped working full-time about 20 years ago. He receives about £20,000 a year before tax from renting three properties in Cumbria and about £11,000 from the state pension. He also receives about £6,000 a year from his work as a self-employed consultant.
This means he has not had to touch his £500,000 self-invested personal pension or his £400,000 investment portfolio held with online firm AJ Bell.
However, in 2008 he withdrew around £30,000 in a single tax-free payment – representing about 12.5 per cent of his pension pot at the time – and used the money to buy a property. His pension has since doubled in size, meaning he can withdraw a further £62,500 (12.5 per cent of the pension’s current value) tax-free.
Hitchin also receives a windfall if his horses win at races. He co-owns two racehorses, Lady Lightning and Free Speech, with three friends. The group paid £13,000 for Free Speech in 2022 and £30,000 for Lady Lightning in October. Training costs amount to about £60,000 a year, which the four owners split between them.
“As a racehorse owner, you don’t expect to make money, but if you consider the value of the horses and their earnings, we’re a little bit ahead of the game,” he said.
