Save Your Pension Pot for Later: A Tax-Savvy Strategy for Your Golden Years

Are you nearing retirement and wondering how to make the most of your savings and investments while minimizing the tax bite? Financial experts in the Daily Mail have a key piece of advice: hold onto your pension pot as long as possible and use your other assets first. This strategy can keep more of your hard-earned cash away from the taxman, especially when it comes to inheritance tax.

Why Keep Your Pension Pot for Last?

Since the pension freedom reforms in 2015, retirees have more flexibility in how they use their pension savings. Many are choosing to keep their pension invested in financial markets rather than opting for a guaranteed income from an annuity or a final salary work scheme.

If you go for an income drawdown scheme when you retire, your pension savings can continue to grow tax-free, unless you decide to withdraw them. Remember, you can take 25% of your pension tax-free, but after that, withdrawals are subject to income tax.

The Inheritance Tax Advantage

One of the biggest benefits of holding onto your pension pot is the potential reduction in inheritance tax. Here’s the lowdown:

  • Inheritance Tax Thresholds: If you’re single, your estate must be worth at least £325,000 before inheritance tax kicks in. This threshold doubles to £650,000 for married couples or civil partners. There’s also an additional home allowance that can increase this threshold even further.
  • Tax on Pension Drawdowns: If a pension pot owner dies before age 75, beneficiaries can receive what’s left in the drawdown scheme tax-free. If the owner is 75 or over, beneficiaries pay their normal income tax rate.

Spending Order During Retirement

To maximise the benefits of your various assets and reduce taxes, consider using them in the following order:

  1. Non-Isa Investments: Start with investments outside of Isas, such as shares, bonds, or property. These can be subject to capital gains or inheritance tax.
  2. Isa Investments: Next, use your Investment and cash Isas, avoiding those in an AIM portfolio that qualifies for business property relief.
  3. Property: Consider downsizing if your home pushes your estate above the £2million threshold.
  4. Investments with BPR Status: These are shielded from inheritance tax if held for at least two years before death.
  5. Pension Pots: Lastly, use your pension pots invested in income drawdown schemes, which are tax-efficient and beneficial for inheritance.

The Role of Business Property Relief

Business property relief (BPR) is a government initiative to encourage investment in smaller businesses. It offers inheritance tax protection on shares held in firms with BPR status for at least two years. However, these investments can be risky, so they’re more suitable for wealthy, experienced investors.

Ensuring Your Pension Scheme Supports Your Plan

Gary Smith from Evelyn Partners advises checking if your pension scheme allows for ‘succession drawdown’. Some older pension schemes might only allow bequeathing to a spouse. Switching to a scheme with succession drawdown is often easy, though some personal pensions might have exit charges.

Martin Bamford of Informed Choice highlights the importance of a diverse asset portfolio for a financially secure retirement. Wealthier investors often focus on inheritance tax planning, making pension pots the last resort due to their favorable tax status.

In Summary

Saving your pension pot for last can be a smart move to maximise your assets and minimise taxes in retirement. This strategy is particularly effective for reducing potential inheritance tax. However, individual circumstances vary, so it’s wise to consult a financial professional for personalized advice. Remember, tax rules can change, so stay informed and plan accordingly for a comfortable and tax-efficient retirement.