Welcome to the Pensions Jungle, we’ve got help and advice…
Navigating the complex landscape of retirement planning can feel overwhelming. But don’t worry, we’re here to help you see the wood for the trees, guiding you through the myriad of options to ensure you make the most of your pension and achieve your retirement goals.
Pensions are primarily for retirement income, but they offer flexibility for a variety of uses. Pension uses include paying the mortgage off, medical and living expenses to supporting family and indulging in personal interests. Understanding the terms of your pension plan and consulting with a financial adviser can help you make the most of your pension while balancing immediate needs with long-term financial security.
Understanding how you can use your pension is crucial for financial planning and ensuring a comfortable retirement. This article will guide you through the potential pension uses so you can make informed decisions.
When can I begin to use my pension fund?
Typically, save for circumstances such as ill health, you’ll need to wait until age 55 to access your private pension, which includes the majority of defined contribution workplace pensions. This is to rise to 57 by April 2028.
What should I use my pension for? Indeed, what should I use a lump sum from my pension for?
An increasing number of retirees are choosing to take a lump sum from their pension and utilise flexi-access drawdown to generate an income. With fewer individuals now purchasing an annuity, it raises the question: is this approach right for you?
Since the introduction of pension freedoms in 2015, retirees have gained greater flexibility over their retirement funds. However, this flexibility has also made pension planning more intricate. Opting not to purchase an annuity means you must take on the responsibility of managing your pension to ensure it delivers sufficient income throughout your retirement.
One of the important choices facing those nearing retirement is whether to withdraw a lump sum from their pension pot. Up to 25% of your pension can be taken tax-free, either as a single lump sum or in smaller, phased withdrawals over time. This option appeals to many due to its flexibility and immediate access to funds.
If you do decide to take a lump sum, what would you use it for?
Many retirees opt to take a lump sum from their pension for various reasons. Common pension uses include paying off existing debts like mortgages or loans to enter retirement debt-free. Others may invest in significant home improvements or renovations to ensure their living environment is comfortable and suited for aging. Travel and leisure are popular, with people using the funds to fulfil long-held dreams of exploring the world. Large one-off purchases are another reason. Additionally, lump sums can help support family members, such as contributing to a property deposit for children or education. Finally, some use the funds to create an emergency reserve for unforeseen medical expenses or other unexpected costs during retirement.
Tax considerations of using your pension to pay off a mortgage
While paying off your mortgage early can lead to a significant decrease in your monthly expenses, there are potential drawbacks to consider. With interest rates now higher than they have been in years, using your pension's tax-free lump sum to pay off your mortgage may appear to be a smart move. However, making this decision one that requires careful thought.
If your 25% tax-free lump sum isn’t enough to fully cover your outstanding mortgage, making an additional taxable withdrawal to pay off the remaining balance may not be financially wise, as it could lead to various additional tax implications.
When interest rates are low, it’s often more beneficial to keep your money in your pension, as the growth potential within the pension is likely higher than the interest rate on your mortgage. However, there are situations where paying off your mortgage may be the better choice, so it’s wise to get advice tailored to your circumstances. Reeves Independent can help you with this.
When interest rates are high, the decision becomes less clear-cut. Your pension may still have the potential to grow at a rate that offers greater long-term benefits than paying off your mortgage early, but this depends on various factors that should be carefully considered.
Do you think being mortgage free is just a pipedream? Reeves Independent can help you reconsider with our case study showcasing how we supported a client in achieving it.
So, can I use my pension to pay off my mortgage?
Well, using your pension to pay off your mortgage can have significant long-term impacts. Withdrawing funds reduces your pension pot, which may lead to a lower income in retirement. Therefore, it may not be a good use of your pension, as this could mean falling short of the lifestyle you planned for or, in the worst case, exhausting your savings entirely. These risks may outweigh the short-term relief of reducing monthly expenses for a few years.
Furthermore, keeping your money invested allows your pension to recover from short-term market downturns and ideally continue growing, helping to provide a stable and sustainable income throughout your retirement.
You could use other vehicles such as an ISA to pay off your mortgage.
What happens if I don’t use all my pensions?
Although you can access your pension at 55, you may not be ready to start withdrawing from it. You can leave it invested. Your pension has the potential to grow over time, though its value can also decrease, meaning you could receive less than you originally contributed. Although not guaranteed, generally, the longer your money remains invested, the greater its growth potential. You can also continue adding to your pension fund to help grow your savings for retirement.
If you don’t use all your pension funds during your lifetime, the remaining balance typically passes to your beneficiaries.
In the Autumn Budget, The Chancellor announced that, starting in April 2027, most unspent pension funds will be included in your estate.
This means that, upon your death, the value of your pensions will be added to your other assets to determine if your estate will owe Inheritance Tax (IHT). If your estate exceeds £325,000 (or £500,000 if you’re leaving your home to a direct descendant), any pension funds over that threshold will be subject to a 40% IHT. That would be a big blow to your beneficiaries.
As such, IHT planning is more important than ever. One of the most common strategies to reduce inheritance tax is to gift money or assets to your beneficiaries during your lifetime. Effective inheritance tax planning can significantly reduce the tax owed on your estate, helping to ensure that your loved ones receive the maximum benefit from your wealth and property. In short, plan carefully, pay less tax and make sure the state doesn’t get its hands on what’s rightfully yours and your families.
If you pass away and don’t have a valid will, the rules of intestacy will determine where your estate goes. Again, make sure you have your say before its too late.
Reeves Independent can assist with your IHT and estate planning. We can also assist you with pension and retirement planning, helping you to secure your future and provide peace of mind for you and your loved ones. Schedule a free review today to begin your journey towards a brighter, more sustainable future.