These Tips are based on frequent or newer questions that we get.
We can’t give you advice, so can’t tell you what you should do. We can help you get the most from Guiide by understanding how to use our tools better.
Many people now ask us – How do I take my pension pots first and leave savings for later?
1. What our calcs currently do
Each and every year we look at what you have in terms of fixed income. This is the sum of your Final Salary pensions, State Pensions and Other income. This is just fixed income. There is nothing you can do to change these amounts once in payment.
We then look to see if you want a total after tax income which is more than this. If so, we need to draw some money from either your pension pots, or savings pots.
So how do we choose where it comes from?
Firstly, anything coming from your pensions pots is subject to income tax. Anything coming from your savings pots you don’t pay income tax on.
But……. you have a tax free allowance each year which you pay no tax on. We don’t know exactly what yours is, but for most people it is £12,570 a year, so we use that and increase it in future years after the current freeze until 2031.
So if you have any allowance left, i.e. your fixed income is zero, or less than this, we firstly take that any remaining amount from your pension pots each year. If you want 25% of each payment tax free, we add another 25% of this amount also. Pension pot income extracted with no tax!
If you still need more, we then start to take it from your savings pots to meet what you want. Overall no tax is expected that year. Result!
We do this until your savings pots run out. Then money must come solely from your pension pots.
2. Why do we do this?
We can’t provide individual advice, so we had to choose a method that would work best for the vast majority of people.
This route meant less tax is paid in earlier years and used up any remaining tax free allowance each year. If someone died their pension pots could also be passed on tax free (as inheritance tax didn’t apply to pension pots but did to savings pots).
It was really hard to come up with a scenario where this route didn’t work best from a “paying less overall tax” perspective.
However, there has now been a significant change. Pension pots are soon to be subject to inheritance tax.
Given this there may be more scenarios where people want to take pension pots first and then leave taking savings until as late as possible.
We must keep to one methodology to avoid providing personal recommendations. This current methodology is still likely to work out best from a tax perspective for the majority of people. No one likes paying tax on death, but less than 5% of households currently actually pay it.
We can’t say what is right for you, and to be honest if you have potential inheritance tax issues you really should take advice on that.
We can show you how to model taking pension pots first, if that’s what you want to do, with a simple workaround.
3. Simple workaround
First take out any savings pots, then run the numbers. If you don’t get any shortfalls, that’s great your pension pots are expected to cover your income and your savings pots can just be held as a reserve.
Many people may get shortfalls after taking the savings pots out. If so, look at the chart of when the shortfalls start. Lets say that’s year 18 as an example.
OK then add some, or all, of your current savings pots in as a cash lump sum the year before, i.e. 17.
This will go straight into savings. If that removes the shortfalls then this would be expected to see you through. It also means you have drawn down your pension pots first, if that is what you wanted.
This is the second in a series of Top Tips. More are on the way!
If you have any question at all as always just contact us at contact@guiide.co.uk.
