Jim Carlton joined us as a client when he was aged 58. He was still working as a freelance software engineer but was hoping to retire within a few years and he was on track to fulfil this ambition, having built up a reasonable pension fund.
However, like many people, Jim had also put by significant cash savings – in his case, about £25,000 – as a rainy day fund. After reviewing his situation and plans, we decided together that he was unlikely to have to call upon this much money and we pointed out to him that, with extremely low interest rates, these savings, for which he had no management and no plan, were not working for him as they could. In fact, with the rate of inflation being higher than interest rates, keeping these funds on deposit was costing him money.
Our advice to Jim was that, while he was still working and earning, it was crucial that he fund his pension as much as possible. The allowance for how much can be paid into pension is determined in part by earnings. Once you stop working, your annual pension allowance drops significantly.
So, following our advice, Jim paid £16,000 from his personal savings into his pension fund. This was immediately boosted by 25% as the taxman gave him £4,000 by way of income tax relief to further add to his pension. This was even before the funds were put to work by the pension fund manager to achieve further – tax free – growth.
If Jim had been a higher rate tax payer, he could have received up to an additional £4,000 refunded back to him by HMRC, so the £20,000 added to his pension, would only have cost him £12,000.
As a result of this decision, Jim brought his retirement ambitions closer, while still retaining £9,000 cash for any emergencies.
Another Reeves client was Mary McAndrew. Mary, who retired when she was 63, had also built up a respectable sum in cash, in addition to her pension fund. When she became a client, she explained that her plan was to live off these cash savings for a couple of years to allow her pension funds to grow before she needed to draw on them.
This is a common attitude and it’s not unreasonable, as it’s a good thing to allow our investments to work for us, for as long as possible, to allow them to build up momentum under the powerful force of compounding.
However, in Mary’s case, she wasn’t taking into account her tax position. Like any other adult, she had a personal income tax allowance of £12,500 a year – that is the amount she could earn without paying any tax. But, as she was retired, she wasn’t receiving any taxable income and so her allowance was unused and going to waste. The personal income tax allowance cannot be carried forward to another year, you either use it in the current tax year or lose it. This same income, drawn later in life, may have fallen into the basic rate tax bracket, meaning Mary would have lost £2,500 when accessing it from pension.
We advised her to draw £12,500 from the taxable element of her pension. Even though she didn’t need that money to live on, she could reinvest it, so that the money could still continue to work for her, while she was making full use of her personal allowance. A case of making the best of both worlds.
Leigh and Rita Collinson were in their fifties. Leigh was a manager for a packaging firm who had worked his whole adult life, during which he had built up a reasonable pension pot. Rita, on the other hand, had given up her career as a hotel receptionist in order to bring up their two children. She had worked in retail once they both reached school age and, while she had saved a modest pension, it was significantly smaller than Leigh’s.
So, when they first consulted us, they had the view that in retirement they would largely be relying on Leigh’s pension, as he had been the traditional `breadwinner’, to provide their required joint income of £24,000 after tax.
We pointed out that the income tax allowance of £12,500 can be doubled for a couple retiring together, that’s £25,000 drawn from taxable environments tax free.
If the income Leigh and Rita wanted was £24,000 a year, by using both of their pensions, they could draw that from a taxable environment, so 25% of their pensions could be drawn tax free. They didn’t have to touch this but it could be saved for when needed and when it was more tax efficient to access it. We used these income tax allowances to pay them their income and the £1,000 surplus was reinvested to continue working for them.
These are just three examples to underline how Reeves has helped people to use the tax rules and allowances to boost their savings.
The content of these articles are for information only and should not be seen as advice or recommendation to act. If you do wish to take action, seek independent advice first as your circumstances may be different to what has been discussed in these articles. When investing, your capital is at risk and it may go down as well as up. You may not get back the original capital invested. Pension investment should be seen as a long term investment. Please note that pension legislation can and may change in the future.
**Names have been changed from real client case studies, with written consent. All other names and studies are fictional to highlight our advice.