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Confused about your pension?: Now pensioners are no longer obliged to buy an annuity, Guardian Money considers your options on retirement. This week we look at a woman retiring with an pounds 80,000 pot

May 17, 2014



What would you do with pounds 80,000 at age 65? Blow it on a (second-hand) Lamborghini? Leave it in a deposit account where you earn only 1-2% in interest after tax? George Osborne's budget bombshell, in which he freed pensioners from having to buy an annuity, will leave millions of people wondering what is the most sensible thing to do with the cash they have saved up over their lifetime.

Each week we set a different conundrum for financial advisers. This week we asked them about a woman (let's call her Sheila) retiring at age 65, having saved pounds 80,000 through her company pension scheme. Sheila has a husband who has already retired from his job as a teacher and has an pounds 18,000-a-year final salary-based pension. They live in a home worth around pounds 250,000 and have paid off their mortgage.

Their daughter is working and earning a reasonable salary, but although she is in her mid-30s, she can't afford to buy a home. What would our advisers recommend?

Take it all as cash and put it in property

If Sheila really wants to help her daugher climb on to the property ladder, now that she's free to do what she likes with her pension money she could withdraw it all and give to her daughter as a healthy deposit on a new home. After all, her state pension - worth pounds 113.10 a week, or nearly pounds 6,000 a year - plus her husband's state pension and his final-salary arrangement add up to nearly pounds 30,000 a year, so they will probably feel relatively well-off.

Martin Bamford, managing director of financial advisers Informed Choice, says: "Helping adult children on to the property ladder is often an objective for retirees, and they will be able to use the tax-free cash from their pension as a deposit on a new home. This could work well, with maybe the child paying rent to the parents on a portion of the property, and the parents benefiting from long-term capital growth in the property."

But - and it's a very big but - if Sheila wants to withdraw her pension immediately, she'll pay a large tax bill of around pounds 16,000. Sheila will be treated as if she earned pounds 66,000 over the year, which puts her firmly into the 40% tax bracket. She can take the first 25% of the pounds 80,000 she had in her pension pot as a tax-free lump sum, but that leaves pounds 60,000 to be taxed in the normal way, to which will be added her pounds 6,000 state pension.

The income tax at current rates will be just over pounds 16,000, leaving Sheila with pounds 64,000 out of the pounds 80,000 to give her daughter. Still, the Treasury is betting that a lot of people will take the tax hit on the chin and withdraw all the money at once - they are pencilling in a big new tax haul in the early years of the post-annuity world.

Buy a new kitchen

This is comfortably within Sheila's means. One thing that has not changed in the pensions landscape is that everyone can still take 25% of their pension pot as a tax-free lump sum, which in her case means she can pocket pounds 20,000 of her pounds 80,000 without paying tax. In Australia, which abandoned compulsory annuitisation many years ago, researchers found that one-third of savers used their pension cash to buy a home, pay off an outstanding mortgage, or make home improvements such as getting a new kitchen or conservatory.

Defer the pension

There is no requirement for those retiring to do anything with their pension pot - they can leave it accumulating by staying invested in bonds and equities. Philip Bray of advisers Investment Sense says: "The first option to consider, which is often overlooked by investors and financial advisers, is deferral. If income or indeed capital is not required immediately, the pension fund should remain invested, providing two key benefits: tax-efficient growth and a tax-free lump sum on death."

Gradually withdraw the money

This is likely to be the dominant theme in the new world of pensions. The idea is that you leave the money invested in your pension plan - preferably in something low risk such as a bond fund - and draw down the money. "This will allow the level of income taken to be altered each year in line with their spending requirements," says Bray.

Hargreaves Lansdown pensions expert Tom McPhail says Sheila's pounds 60,000 would translate into a sustainable income of around pounds 2,000 a year. "If she chooses to use drawdown and to take out more than around pounds 2,000 a year in the early years, then she'll probably start to run down her fund. Whether that's OK is up to her."

At Skipton Financial Services, adviser Gareth Smith says that if Sheila's husband dies - and they therefore lose his pounds 18,000 a year pension - then she will then be able to access the money in her pension to prop up her income.

Buy an annuity

Sheila's pounds 80,000, after taking out the pounds 20,000 as a tax-free lump sum, will give her a basic annuity of around pounds 3,500 a year, according to the Money Advice Service, which has a useful comparison tool which lets anyone find a best-buy annuity. This has all the usual drawbacks of annuities - principally the income dies when you die - but if you reckon you have decent longevity, they can still be part of your retirement planning. For more help on annuities, go to moneyadviceservice.org.uk.

Join the debate: Next week we'll look at a man retiring at age 65 with a large private pension pot worth pounds 300,000, a full state pension, and a wife who has a small final-salary pension of pounds 5,000 a year. What would you recommend? Email us at money@theguardian.com

Patrick Collinson

25%

The amount

of your pension

pot that you

are allowed

to take as a tax-free lump sum



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Source: Guardian (UK)


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