More than three years since the ‘pension freedoms’ were introduced, retirees now have greater flexibility to invest and spend their pension pots as they wish. This means that people are faced with important decisions in the run-up and during retirement that will affect whether they have enough money to support their lifestyle and objectives when they stop working.
One of the most common dilemmas is whether to transfer a legacy pension fund. This is likely to come up if you are changing job; your pension scheme is closing; you wish to transfer into a better pension scheme; or you have pensions from previous employers that you would like to combine.
Another question that a retiree may face is whether to cash in all or some of their pension pot. This article aims to help anyone who is grappling with these questions and may be considering whether or not to consult a financial adviser.
What is a pension?
Your pension is a pot of money that you and your employer pay into, which is used to fund your retirement. One of the biggest attractions of investing into your pension is the tax relief offered on contributions, which stands at 20% for basic rate taxpayers, 40% for higher rate taxpayers and 45% for additional rate taxpayers. Pensions typically come in two forms - ‘defined contribution’ or ‘defined benefit’. Here’s how they work:
This type of scheme pays out a set income every year during retirement and is largely funded by the employer - although an employee may make contributions throughout their career. They come in two forms: firstly, ‘final salary’ which offers a retirement income based on a proportion of the person’s final salary. Secondly, a career average revalued earnings (CARE) scheme, which pays out an income based on an individual’s average salary across their career. In both types of scheme, pension income is linked to inflation.
This type of pension (also known as a money purchase scheme) does not promise to pay out a set amount during retirement. Instead, it is down to the individual and their employer to make contributions, building up the savings pot over time. If it is a workplace scheme, the person decides how much they wish to pay into their pension as a percentage of salary and the employer will match all or some of these contributions. Alternatively, if it is a private pension, it is down to the individual to make contributions.
Can I manage my pension myself?
A popular type of defined contribution pension is a Self-Invested Personal Pension (SIPP), which provides an individual with the flexibility and autonomy to hold the investments they wish within a pension ‘wrapper’. This contrasts with a final salary scheme, where the individual has no control over how the investments are managed.
The following investments can be held within a SIPP:
- Exchange-traded funds
- Investment trusts
- Gilts and corporate bonds
- Commercial property
If you decide to take the DIY route with your SIPP, it will be your responsibility to select the underlying investments for the portfolio via a broker or platform. The first step is to choose a platform which offers competitive charges. To find out more, check out our article which looks at the cheapest SIPP providers.
It is then a case of selecting your investments. It is important to note that with freedom comes responsibility, so it will be down to you to make sure you have enough income to fund your retirement – something that can be achieved by adopting a ‘drawdown strategy’. This means drawing a variable income directly from your portfolio and keeping some money invested in the stock market during retirement. The aim is to grow your income, hopefully as the value of your investments increases over time.
An alternative is to take out an annuity, where an individual exchanges their pension for a secure income for life. These are generally provided by insurance companies.
If you prefer for someone else to manage your SIPP, you can appoint an adviser, wealth manager or robo-adviser. The latter are online investment managers, such as Wealthsimple, Nutmeg and Moneyfarm who use computer models, known as algorithms, to manage portfolios. Their services are lower cost than traditional wealth managers but involve little to no human interaction with their customers. Nutmeg, Moneyfarm and evestor currently offer SIPPs. They manage the money on your behalf and typically offer some input in relation to aspects like determining your risk profile.
How to get free pension advice
Under the pension freedoms, introduced in April 2015, free and impartial pension guidance is available for all individuals who are aged 55 and over. Retirees can access this guidance via The Pension Advisory Service or through their employer’s pension scheme provider.
MoneytotheMasses.com readers can also get a free 30-60 minute pension consultation in partnership with VouchedFor.
When should you consider getting pension advice from a financial adviser?
While these services have helped many retirees so far, there are a number of scenarios where it could prove useful to seek more tailored advice from a financial adviser. In the examples below, financial advice is not mandatory but it could prove beneficial:
Leaving your pension in a will
Since the pension freedoms were introduced in April 2015, it has become easier to leave some or all of your pension to loved ones. The best part is this can be done in a tax-efficient manner. For example, if you die before the age of 75 your beneficiaries will not have to pay any tax if they cash in the pension pot.
After the age of 75, beneficiaries can still inherit the pension free of tax if it remains invested. However, if they want to draw an income from it or cash in the whole thing, they will have to pay income tax on the amount they take out.
From the age of 55 you can take up to 25% of your pension pot tax-free, so it could make sense to take this lump sum before you turn 75. After this point, it becomes part of your estate and is therefore subject to inheritance tax.
Older pension schemes may not allow you to pass on your pension within your will. A financial adviser can give you a clearer idea of what is possible, helping you to get your affairs in order with the aid of other professionals, such as accountants and solicitors. They can also guide you on how much you can afford to leave to loved ones.
Investing your pension to get adjustable income
It may make sense to take an adjustable income from your pension pot during retirement. Also known as ‘flexi-access drawdown’, this is only possible with defined contribution schemes. After the 25% tax-free lump sum is taken, the remaining 75% of your pension pot is invested in funds that allow you to take a regular income (which is then taxed at your marginal rate). Your investments will be guided by your objectives, requirements and attitude to risk. In addition, the investment strategy can be adjusted over time, in line with your circumstances and the performance of your investments.
A financial adviser will be able to provide some guidance on how much income you are likely to require. If you aren’t an experienced investor, they can also construct an investment strategy that focuses on delivering the income you require.
Combining pension options
It may make sense to combine pension options. For example, by using some of your pot to buy an annuity and investing the rest to generate an adjustable income. If you are thinking about the practicalities of doing this, you will need to explore whether your pension provider offers both options. Alternatively, if you have two pensions you could buy an annuity with one pot and invest the other.
The most important thing is to have a clear financial plan in place. This will be led by your objectives and the estimated amount that is required during retirement. You may wish to consult a financial adviser to put a financial plan in place or to discuss the implications of combining different pension options.
Changing your pension contributions
The level of contributions into your pension will be driven by a range of factors. These include how much you can afford to put in, the amount of retirement income you are targeting and the age you wish to retire at. It is also important to consider the tax relief that is available on contributions. During the 2018-19 tax year, you can receive tax relief of up to 100% of your earnings or a £40,000 annual allowance – whichever is lower.
You may wish to consult a financial adviser to discuss whether you are on target to retire at your desired age. This will inform your thinking about whether to increase or decrease pension contributions. You can also use our pension calculator to obtain a quick estimate of your potential retirement income.
When must you seek professional pension advice from a financial adviser?
Financial advice is either strongly recommended or it can represent a legal requirement in the scenarios outlined below:
Do I need a financial adviser to make withdrawals from my pension?
Since the pension freedoms were introduced in April 2015, it is possible to cash in all or some of a defined contribution pension pot from the age of 55. Once the 25% tax-free lump sum has been taken and your Personal Allowance (equating to £11,850 during the 2018-19 tax year) has been used up, any withdrawals will be taxed as income.
It is important to think about the tax implications associated with making withdrawals; a financial adviser will be able to provide you with some insight on this. For example, if a substantial proportion of your pot is withdrawn in one go, it could push your tax rate up. Think carefully about the impact this could have on the amount you ultimately receive.
Here are four different approaches to taking withdrawals from your pension:
- Take your 25% tax-free lump sum and leave the rest invested until you need it at a later point.
- Withdraw some of your lump-sum tax-free and leave the rest invested in the hope that your investments continue to grow over time. Of course the opposite can happen and your investments can also go down. This strategy is known as partial drawdown.
- Withdraw more than your 25% lump sum, which means you will have to pay income tax on the amount above the 25% threshold. The rest of your pot then remains invested until you need the money later on.
- Uncrystallised Funds Pension Lump Sum (UFPLS) – you take your 25% tax-free lump sum in stages and pay tax on the remaining 75% that is withdrawn. This strategy is typically used if a pension scheme does not allow you to go into drawdown. Alternatively, there may be tax benefits associated with taking your tax-free cash at various points.
Do I need a financial adviser to buy an annuity?
It isn’t mandatory to consult a financial adviser if you are thinking about buying an annuity. Nevertheless, many people find it useful.
For those who are happy to select an annuity by themselves, the first step is to choose which type of annuity works best. There are two main categories:
- Basic lifetime– where you specify an income from the outset
- Investment-linked annuities– this means your income will be linked to the performance of underlying investments, so it could fluctuate. However, it will not fall below a guaranteed minimum.
The amount paid out by the annuity will depend on your health and age. For example, if you are older or have a medical condition, you will receive a higher income (annuity rate). This reflects lower life expectancy.
There are a number of online annuity comparison sites available, including the Money Advice Service website. However, some annuity providers do not offer quotes online, so the websites aren’t necessarily showing you the whole market.
This is where a financial adviser can come in useful because they can help you to find a better rate. They can also provide guidance on which annuities are most suitable, given your circumstances.
For those who are keen to take the DIY route, there are two main obstacles to be aware of. The first is that some of the more commercial annuity comparison websites charge commissions for arranging the product, so it is important to look out for these and consider how they compare to a financial adviser’s fee. Secondly, many providers won’t provide a direct quotation and require the individual to receive financial advice before they sell the annuity.
Do I need a financial adviser to cash in my pension?
Retirees with defined contribution pensions now have the freedom to cash in their entire pension pot from the age of 55. Of course, there are tax implications associated with this course of action, so it is a good idea to seek financial advice before taking this decision.
Cashing in your pension to buy big-ticket items or to clear debts will affect the amount that is available for you to live on through retirement, so this must also be considered.
Legally, individuals are required to seek financial advice if they wish to cash in a defined contribution pension that is worth more than £30,000, where there is a guarantee about the amount that will be paid when they retire. For example, through a guaranteed annuity rate.
If your pension pot is less than £30,000 and does not have a guarantee regarding income, it could still be a good idea to seek financial advice before you cash it in – not least to consider the long-term implications and potential tax liabilities.
If you are considering transferring your defined benefit pension over to a defined contribution scheme, you are legally required to consult a financial adviser if your pot is more than £30,000. If you are advised to proceed, you will be given a transfer value and this will then be converted into a lump sum and transferred into a defined contribution pension.
How much will a financial adviser charge for pension advice?
The average cost of an initial review stands at £500, according to research produced by Unbiased. Meanwhile, for a £200,000 pension pot there was an average at-retirement advice fee of £2,500. The average hourly rate for a UK adviser is £150, according to The Money Advice Service. However, some advisers charge as much as £300.
If you are exploring your options, be prepared that charges may vary from firm to firm. Before proceeding, ask the adviser to provide an estimate of the overall charges (not just the headline fees), as well as when they expect you to pay them. Also, find out if there is a fee for an initial consultation.
How to find a reputable financial adviser near you
When it comes to choosing a financial adviser, it may feel like that information overload. However, fear not - there are a number of services out there which are designed to help consumers to find a reputable adviser who can meet their requirements. These include VouchedFor*, Unbiased, Financiable or the CISI’s WayFinder.
Here’s a checklist of things to look out for when selecting a financial adviser:
- What is the advice fee or structure?
- Total charges & costs – for example, platform charges, trading costs and underlying fund charges
- Recommendations – do you know anyone who has used them? What do online reviews tell you
- How does their investment process work? Is it easy to understand?
- How well-resourced is the business?
- Do they have relevant experience?
For a comprehensive list of things to check when choosing a financial adviser read our article 10 tips on how to find a good financial adviser.
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