If there’s been a regular drumbeat from advisers in media commentary post-pension freedoms, it’s that those taking advantage of the freedoms should be aware of the pitfalls of treating their pension like a bank account. Nonetheless, HMRC’s latest update showed the cautionary messages are having little effect. The Treasury expects a £400m bonanza in additional tax receipts from flexible pension withdrawals this year1, as thousands of over 55s who can access their pension pots take out withdrawals over and above their 25% tax-free allowance – in some cases several times a year.
Releasing this much from a pension pot doesn’t come cheap. A higher rate taxpayer in work taking out £20,000 from their pots above their tax-free allowance has to pay at least £8,000 in tax on that amount, as it counts as income akin to their salary. Indeed, they may potentially have to pay more if the amount they take out tips them into the top tax bracket. And not only does it come with a tax hit. Because of the Money Purchase Annual Allowance, anyone who starts drawing on their pension (even if they’re still in work) can then only contribute £4,000 to their pension pot per year thereafter – limiting the potential growth of their pot and the amount they’ll have when they reach retirement.
Yet despite this, nearly £6bn2 was taken out of pension pots in taxable withdrawals in the first three quarters of this year – more than in the whole of 2016.
Plenty of those paying thousands of pounds in tax on each withdrawal will think it worth the trade-off. But there will doubtless be many looking for an alternative when it comes to cash lump sum options. For brokers advising such clients, a viable alternative worth exploring is the range of Home Finance products now available to over-55s.
The sheer amount of innovation that the Home Finance sector has seen over the last few years means that more and more products – including later life buy-to-let mortgages – are suitable for a range of circumstances, offering homeowners flexibility. While many may already know about equity release products that allow the interest over time to roll up and be paid off with the sale of the property, more recent options that allow homeowners to make capital and interest repayments without incurring charges could well be more suitable for some situations than making withdrawals from pension pots. One advantage this route has over withdrawals is that it’s tax-free.
Home Finance options won’t be suitable for all situations. But given the clear trend in over 55s looking for cash lump sum options, brokers should be looking at retirement income holistically, including property alongside pensions, investments and other assets.