Following the Budget on Wednesday and its relaxation of pension rules, here’s what I think is a foolish pension planning idea.
It’s something I’ve seen hinted at since the Budget and believe needs to come with a serious wealth warning.
From April 2015, it will be possible to take the 25% tax-free cash from your defined contributed pension fund and then draw the balance as taxable income.
In reality, this is nothing new. Under current pension rules, flexible income drawdown has allowed exactly the same thing to take place, assuming you can satisfy the £20,000 a year Minimum Income Requirement with secure pension income first.
From 27th March 2014, that Minimum Income Requirement is falling to £12,000 as a transitional measure. It then falls to zero on 6th April 2015, allowing for this much hyped new level of pension flexibility.
So what is this foolish pension planning I referred to at the start of this blog? Here it goes.
A pensioner reaches retirement, takes their 25% tax-free cash and then draws the balance of their pension fund as taxable income, paying whatever marginal income tax rate they happen to be paying at the time.
They take the capital now sitting in their bank account and invest it in a buy-to-let property, so the rental income can provide an income in retirement and property can grow in value to provide an inheritance for their children.
On the surface, this sounds like a reasonable idea. The average gross yield on a residential property in the UK is currently 5.8%, falling to 4.1% net after costs and void periods.
Sure, it’s a lot less than a typical annuity will pay a 65 year old, particularly if you are in poor health, but it does at least come with continued access to the capital and potential for some capital growth, particularly if the government continues to heat up the property market as they have been doing of late.
So why is this foolish pension planning?
Purely from a tax perspective, it involves taking funds out of a nearly tax-free environment, paying income tax on three-quarters of them to remove them from the pension fund and then investing in a taxable property which generates a taxable income.
From an investment perspective, this foolish pension planning massively ramps up the risks involved; moving from a well diversified portfolio of professionally managed funds across all major asset classes to a single asset. This is high risk investing.
For elderly investors, managing a residential property, expensive repairs, disrespectful tenants and sometimes lengthy void periods just sounds like a really bad idea.
The vast majority of retirees we speak to simply cannot afford anything other than the guaranteed income that comes from an annuity. Nothing has changed when it comes to that.
What I fear is that this foolish pension planning will become mainstream, with some parts of the media lauding the idea as a result of the new found pension flexibility. No doubt many estate agents and less than reputable property investment gurus will be chomping at the bit to encourage retirees down this path as well.
If following the Budget you’re thinking about drawing every last penny from your pension fund and then gambling it on the buy-to-let property roulette wheel, please seek professional advice first.
The same goes for anyone who is ever tempted to ‘liberate’ their pension fund and invest the proceeds in unregulated overseas investment scams. We have seen too many examples of these going wrong, with elderly investors losing their life savings, for them ever to be considered a good idea.
Foolish pension planning is a foolish idea. Stick with what works and take action which is considered, suitable and tailored to your personal retirement objectives, rather than what is now possible or seemingly clever, just for the sake of it.
