Research by the Citizens Advice Bureaux reported in The Telegraph on 25th August 2016, suggests that one in three people taking money from their pensions funds are just putting it in the bank. (See the original article here ).
As an IFA, I see this is just the sort of behaviour that good advice would prevent, as an advised new pensioner would understand the drawbacks. If you drill down to the basics, there are three major reasons why taking pension money out of the pension and putting it in the bank is a bad idea.
Taxation. A pension is a special case in tax law; whatever is in a pension wrapper is exempt of income and capital gains tax. The first 25% can be drawn out tax free, but the balance is treated as earned income. Once you have drawn the money out, you will be liable to income tax on the 75% you have taken. This can push you into a higher tax bracket, losing money unnecessarily.
Investment returns. Bank current and deposit accounts are not known for good interest rates; in fact, they are universally dire. Rates of 0.5% or less are not uncommon, so just keeping pace with inflation is not normally possible. If the rumoured negative interest rates come to pass, then this will become much more serious.
Inheritance Tax. Most unspent pension money falls outside of your estate on death and can pass to your spouse or dependents free of tax up to age 75. Pension money you have drawn out and put in a bank will be part of your estate, whatever your actual intension.
If you are a low risk person, then buying an annuity with the entire fund or re-investing the tax free cash makes good sense, but everyone else needs to think very carefully what they are trying to achieve. If you are wanting to use drawdown to finance your retirement, then you will need to leave your pension money invested.
Leaving it in a pension wrapper, (although you may need to find one with flexi-drawdown facilities), should keep the investment return up and the costs down, as pension contracts can be very cost effective. You are now an “investor”, rather than a “pensioner”, so only draw off the money you need, when you need it and leave the bulk of your pension money invested for as long as possible.
Given average luck, a combination of tax free cash and ordinary pension income, should enable you to pay minimal tax for some years to come, with the uncrystallised tax free cash also having an opportunity of growing with investment returns. This virtuous circle should make this “Phased Retirement” last longer and help spin out your funds for longer.
Just taking pension money out of the pension and putting it in the bank is pointless and will cost you dearly in missed opportunity; this is just a variation on being a fashion victim. Just because you can does not mean you should!
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