Pensions Freedom, an Alternative View
Much has been written in the press about the changes to the way you can access your pension fund through Pensions Freedom. In some of the more enthusiastic articles the major disadvantages have been ignored. As a rule of thumb one quarter of the fund is tax free with the remainder attracting tax of up to 45% on withdrawal, although this is not always the case under Pensions Freedom. This tax hit can make taking lump sums from your pension much less attractive than it would initially seem.
Taking the above into account, if you are over 55 and wish to use Pensions Freedom there could be situations where taking a portion of your pension fund early could be the best idea.
For example, many people have built up credit card debt and consequent repayments over the years, releasing money from your pension through Pensions Freedom could not only pay off this debt but also give you a bigger pension fund. This could work for you if you have a UK pension fund that you are not currently taking money from.
This is how it works
- James from Cambridge is 55 and has amassed credit card debts of £25,000.
- The repayments are £551 per month, this will take him 10 years to pay off the debt.
- Over the 10 years this would cost him £66,040.
How his pension can help under Pensions Freedom
- James has a pension fund of £100,000. He can take £25,000 from the pension tax free, while leaving the balance to be available to provide a pension income when he wants to retire.
- James uses the £25,000 to pay off his credit cards, leaving him better off by £551 per month.
- If he pays £551 per month back into his pension this will be boosted by an extra £137.75 per month.
If James carries on the way he’s going now, his pension fund value could be £120,000.
If however he had used Pensions Freedom as above his pension fund at the same rate of growth could be £182,000, meaning that his monthly payments have worked for him, not the credit card company.
This is just one example of how an alternative view could work, clearly everybody’s individual circumstances are unique to them and you should discuss this with us or your independent financial adviser.
Interest Rate 23.95% APR, TSB Mastercard rate.
Pension fund invested to age 65, growing at a rate of 5.37% per year, adjusted for inflation. The fund can grow at more or less than this.
The figures assume basic rate tax relief, this could change in the future.
Once the first tax free amount has been taken a tax free lump sum is only available from the fund provided by new (“uncrystallised”) contributions.
Taking benefits early will almost certainly reduce your pension income in retirement. This scenario will only work in particular circumstances.
Care has to be taken not to fall foul of HMRC’s PCLS Recycling Rules, professional advice is essential.
Clearly credit cards should only be used for short term borrowing, it would be better for clients if they could avoid the above situation in the first place.
The views expressed in this article are not to be construed as personal advice. You should contact a qualified and ideally regulated adviser in order to obtain up to date personal advice with regard to your own personal circumstances. If you do not then you are acting under your own authority and deemed “execution only”. The author does not except any liability for people acting without personalised advice, who base a decision on views expressed in this generic article. Where this article is dated then it is based on legislation as of the date. Legislation changes but articles are rarely updated, although sometimes a new article is written; so, please check for later articles or changes in legislation on official government websites, as this article should not be relied on in isolation.
This article was published in May 2016
See various video’s about this at our channel TAILORMADE FUTURE.
This was first published by John Reid, Aisa Professional
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