Things To Be Aware Of When Drawing Down On Pensions
Income drawdown is a way to receive income on a regular basis from your personal pension pot but keeping it invested so your capital can continue to grow. The percentage growth of the fund will be dependant on market performance. If your investments do well, your pension fund can carry on growing which means your retirement income will increase too. Conversely, the value of your income could also go down if your investments do badly. More and more people are accessing their pension pot before the state pension age.
Here are some common pension drawdown mistakes to be aware of:
Money Purchase Annual Allowance.
You can get tax relief on pension contributions up to £40,000 a year or 100% of your taxable salary. But if you start taking income from a defined contribution pension scheme, you could trigger the money purchase annual allowance (MPAA) which will reduce your yearly pension allowance to just £4,000 in the tax year down from £40,000.
Emergency rate income tax.
Many retirees may not be aware that when they opt to draw lump-sum payments from their pension pots, an emergency rate income tax is applied. According to HMRC, this is done as there is not enough information about the pension saver’s overall tax position in the first year of drawdown. The important thing to remember is that the tax deducted from your pension lump sum will almost certainly be too much and you must make sure that you get this money refunded.
Taking too much tax-free cash all at once.
Tax free cash is the amount of money available ‘tax free’ to the pension saver as a lump sum after minimum pension age. In most cases this limit is 25% of the value of the pension subject to available lifetime allowance. You may be able to draw money out of your ‘pot’ very flexibly – as much as you like, when you like, from age 55. But do not rush. Making a hasty decision could cost you heavily in the form of an unwanted tax bill. However; tax is not the only factor. There might be other reasons you need more money sooner. You will need to take into account possible future changes in your circumstances and you will have other investment-based issues to think about.
Choosing the wrong investments.
Before you make any investment decision, sit down and take an honest look at your entire financial situation. The first step to successful investing is figuring out your goals and risk. There is no guarantee that you’ll make money from your investments. But if you get the facts about saving and investing and follow through with an intelligent plan, you should be able to gain financial security over the years and enjoy the benefits of managing your money. Some investors are choosing investments that are best for long term strategies rather than short term income needs. It is important to figure out what your long and short term goals are.
You do not have to take all of your tax-free cash in one go.
If you have no immediate plans to use the cash, it is best to leave your money invested in portfolios made up of equities and bonds. This should give you a higher return than cash in the bank over the long run. If your money stays in your pension pot you won’t pay tax on it and you’ll get tax-relief on the contributions you make. It may be possible to mix and match what you do with your pension pot at different points in your retirement. Take time to think about the benefits and considerations of each option.
Not taking financial advice.