What are leaks from your pension pots?
Jenny has saved consistently into her various pension pots over the years. She has also taken advantage of the available contributions from her employer where possible.
When she retires in a few years time, she wants to enjoy the pension freedoms and she wants to withdraw an income from her various pots over her years in retirement. But it’s not easy to make a plan that takes into account all of her pots, calculates how much she needs to withdraw every year and ensures she doesn’t run out of money. That’s why we built Guiide: to help her do all this for free.
To make the most of her plan, Jenny wants to make sure she’s not losing money unnecessarily and is aware of potential “leaks”. There are two main pension pot leaks: income tax and provider charges. Let’s break down what those two leaks entail:
Leak 1: Income Tax
Income tax is applied to the majority of the income Jenny takes from her pension pots when she retires. She broadly has two choices at retirement when using the pension freedoms:
- She can take 25% of her pots tax-free immediately
- She can receive 25% of every payment she takes tax-free.
Aside from this tax-free income, any other income she takes from her pension pots is taxable. She will therefore have to pay tax on the rest of her income if it exceeds her tax-free allowance (currently £12,500 per year)
How can she minimise her tax?
If Jenny has savings pots (which can be taken as income tax free) or other non-taxable income, she could combine both revenue streams to pay the least amount of tax possible.
Here’s an example:
If Jenny wants to withdraw £20,000 per year, she could take £12,500 from her pension pots and another £7,500 from her savings. Her total tax bill? £0!
However, it is likely to be a little more complex than that. She may have other income that is taxable, such as her state pension. She may also be able to take more than £12,500 from her pension pots if she decides not to take the 25% tax free cash at retirement.
By using Guiide, Jenny can create a tailored retirement plan that will optimise her tax bill and make sure she’s not paying any more tax than she should. Guiide will also show her the total amount of money she can save over her lifetime by withdrawing money in the most tax efficient way.
Leak 2: Provider Charges
Jenny will pay fees to her pension provider (or providers) before and after retirement. These fees can be overly complex and difficult to understand. They mostly consist of:
- An annual administration (or platform charge), which is typically a percentage of total funds
- An annual investment fund charge for each fund she invests in, charged as a percentage of her funds
- Dealing costs, which apply every time her funds buy and sell investments
- Additional one off or regular charges, such as when she accesses her pots at retirement
Due to the complexity of these pension charges, it can be difficult for any person who isn’t a financial expert to work out what they are paying every year in fees. According to This is Money, total average fees range from 1.5% to 1.8% of fund values every year!
Is it ever worth paying these higher charges?
Paying higher charges is only worthwhile when the higher cost funds invested in, achieve higher returns, after charges, than lower cost funds, after charges. In practice, this may be achievable or it may not, but there’s a lot of debate and research on the subject.
For a non-financial expert like Jenny, taking this additional risk on top of all of the other risks does not seem like the best option. To minimise her risk and fees, Jenny’s best course of action might be to use a pension provider that has low cost funds and charges all-in-one and clear fees that include the cost of the underlying funds. Jenny can then see clearly how much she expects to pay every year in charges. All of Guiide’s partners are pension providers that offer simple low cost funds, with all inclusive, crystal clear charges.
Guiide’s retirement plan shows Jenny how much she can save over her lifetime by using one of our partner providers, compared to the average or her current costs. Paying 1.5% compared to 0.5% in fees every year may not sound like much, but for Jenny aged 55 and with £200,000 in pension pots, this can add up to around £35,000 over her lifetime. By paying something more like 0.5% in fees, Jenny has more money for her own income.
Nobody likes leaks except plumbers! By using a retirement calculator like Guiide, you can build a plan that helps you save on any unnecessary taxes, fees and plug these leaks. Best of all, it’s free to use!