Rob in a field herding sheep

Real Family Finances

Making the most of your pension

How your pension can help you, your family and your business

Farmer and business owner Rob Davis wants to know how his retirement savings can help him gradually step back from the family business. Richard Foreman, Chartered Financial Planner at NFU Mutual, offers his expert guidance.

Pension freedom rules, introduced in April 2015, allow savers to cash in some or all of their pensions from age 55.

When that time comes, you may feel uncertain about how you should use your retirement savings.

While everybody knows that a pension is designed to provide income in retirement, few realise that a carefully thought out pension strategy could offer families so much more. 

Freedom to use your pension how you want

Pension freedoms have been welcomed because they give the over 55s absolute control over how they take money from their pensions.

You could use some or all of your pension pot in these ways:

  • Buy an annuity — giving you an income for life
  • Draw lump sums — you could withdraw it all or smaller sums to top up your income
  • Leave it invested — allowing you to draw an income from the fund if needed, while your money benefits from the growth potential of the stock market.

Many like to mix and match; one option would be to take advantage of rules allowing you to withdraw 25 per cent of your pot as a tax-free lump sum, then leave the rest invested. You could make regular withdrawals before finally locking into an annuity at a later date.

Avoid the pension tax traps

You must think very carefully before taking your entire pension pot as a lump sum. Although you can withdraw 25 per cent tax-free, the remaining 75 per cent is added to your earnings for that year, and is subject to Income Tax.

Taking a large sum could easily tip you into a higher income tax bracket, so that you face tax rates of 40 or 45 per cent on part or all of your pot.

While the money is in a pension, it is free of UK Income Tax, Capital Gains Tax and normally Inheritance Tax (IHT). When you take it out, you are potentially exposing it to all three of these taxes.

To take money out of a pension and simply put it in a bank account earning a low rate of interest that may also be taxable is unlikely to be the best option for many.

You should be particularly careful if you are still working. In that case, it may be better to stick to the tax-free cash, and leave the rest of the fund untouched until you have stopped working. This is because you can take your 25 per cent tax-free cash without problems, but if you draw a penny of taxable income, the maximum you or an employer could pay into your pension falls to just £4,000 each tax year.

Make sure your pension lasts you a lifetime (and more)

There are several reasons to keep your pension invested for as long as possible. Your life expectancy may be longer than you think, and if you spend your pension too soon, you may find you do not have enough income in later life. Nobody wants to spend their final years scraping by on the state pension alone.

Also, you can now pass your pension on tax-efficiently to your loved ones when you die, as it is not normally subject to IHT.

If you die before 75, your beneficiaries can take the income or a lump-sum free of tax. If you die after age 75, they will pay Income Tax on the money they take out.

Pensions can help your business succession plans

Many farmers and business owners continue to pay money into a pension even when they have no intention of taking it during their lifetime. They benefit from tax relief on their contributions and can leave the money to children who may not inherit part of the farm or business.

A sizeable pension pot can also ease succession planning. For example, it could mean that the older family members can take less from the business, leaving more for the younger generation. The younger family members may also be able to use their pension funds to buy commercial property or farmland from the older generation via a self-invested personal pension (SIPP).

Speak to the experts

Pensions can be complicated and it is important to consider taking financial advice to avoid potentially costly and irreversible mistakes. Find out more of about our Financial Planning Service.