We know that A-Day brought flexibility in managing retirement income. Some opportunities were used by advisers, often with great advantage to the client.
But there are other possibilities that are less well understood and are used less often. These could be attractive in meeting clients’ income requirements in a tax efficient manner.
So what changed at A-Day?
A significant change at A-day was the separation of the tax-free lump sum and starting pension income. For clients who choose unsecured pension (or income drawdown), there is no requirement to take any income until age 75.
We see this being used extensively. Indeed the most common route into drawdown is to take tax free cash, often while the client continues to work, but to delay income withdrawals until retirement – or in some cases later.
It sounds attractive to clients to get their tax free lump sum early and I’m sure use it effectively. But there are other possibilities that I’ll cover later. One is “income recycling”; the other involves phasing the tax free lump sum and using it as a means of supplementing retirement income.
A-Day also introduced the concept of designation. What does it mean?
Designation is the process of moving money from a pre-retirement state into unsecured pension. This can now be done within a single arrangement whereas before A-Day it generally needed a complicated combination of phased retirement and income drawdown plans. All of this involved greater complexity and cost, which is passed on to the client.
The result now is an integrated plan with both pre and post retirement elements. Your client can designate part of the pre-retirement fund across to post-retirement, take a tax free sum and use the balance to provide pension income.
Again the most common application of this is for the client to move across just enough to provide the required lump sum, but then defer taking income until it’s needed. But there may be a more efficient alternative - “income recycling”
So what is income recycling and how does it work?
Let’s look at a client who takes the tax free lump sum, continues to work and has no immediate need for pension income. There is opportunity to make further pension contributions and to take pension income to replace this amount. Tax relief on the pension contribution can offset tax paid on pension income.
The big advantage with income recycling is that the further pension contributions increase the pre-retirement fund, which can provide additional tax free payments in years to come.
Income recycling can also be more beneficial in relation to lump sum payments on death. Remember that lump sum payments from the post-retirement element of the fund will be subject to a 35% tax charge. By contrast, the further contributions increase the pre-retirement fund, where there will normally be no tax payable on lump sum payments.
The final opportunity that I’ll mention is to phase the tax free cash payment to supplement the ongoing pension income
Retirement for many people is a journey rather than a single event. Some clients may reduce their hours gradually or undertake consultancy work. These clients may have less need for a one-off tax free payment and will look for flexibility to top up their earnings with pension income. The post A-day regime allows exactly that.
The tools that can be very useful here are:
- Flexible use of pension withdrawals to top up earned income, and
- Regular designations to release tax free payments over time that supplement taxable income
For example, a client may wish to manage taxable income in retirement to a level that remains within the basic rate tax band and top this up with a tax free payment each year.
The added advantage of this approach is again that some funds remain in the pre-retirement element, with more favourable treatment on death. Indeed there is an additional risk with the traditional approach that part of the tax free lump sum remains unspent within the client’s estate and is included in the assessment of inheritance tax.
Finally, this approach can also be used in conjunction with income recycling provided that contributions can be justified by reference to earnings or are within £3600pa.
So in summary, there are beneficial ways to use the post A-Day regime to manage your clients’ income in retirement.
This is an area of financial planning where advisers can add real value, ensuring the required level of retirement income is paid in the most tax efficient manner. And it’s an area where you should look to providers to offer products and tools that support you in delivering these objectives.
Iain McGowan is head of retirement income & planning at Scottish WidowsIFAonline
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