Flexi access drawdown is the preferred retirement option for many but how are pension funds being utilised? One potential route is to use the 25% tax-free pension lump sum to pay down debt. Depending on personal circumstances using pension funds to address debt may (or may not) be a sensible way forward. In this post we review the key factors to consider.
It is vitally important not to rush any decision but to take the time to carefully consider all the options. The wrong choice of pension fund, fees and tax issues could easily cost the unwary thousands of pounds in potential retirement income.
If the debt situation is serious, perhaps with the prospect of court action or repossession, it remains important not to make snap decisions but to talk the situation through with a debt charity, citizens advice, or a Financial Adviser. A wrong decision could actually make a bad situation worse.
If already managing debts via Individual Voluntary Arrangement (IVA’s) or Debt Management Plans (DMP’s) it is again important to seek debt advice. Your creditors may have a claim on any funds you access as a pension lump sum. If taking any state benefits it is also important to assess the potential impact on those benefits of any pension fund drawdown arrangement.
If you are in a stable debt situation then the key issues to consider are
- Alternative solutions.
With average lifetimes increasing, and the potential impact of long-term care costs it is important to look carefully at any alternative solutions to debt management to leave a pension fund intact. Every situation is different and it is important to take advice from a suitably qualified and experienced adviser who can calculate and compare the impact of each potential way forward.
It is important to remember once drawdown income is taken a £10,000 limit exists (dropped from the normal £40,000 limit) on the amount that can be invested (per annum) in a pension fund and continue to secure tax relief. This limit will drop further to £4,000 in April 2017.
Transferring a pension fund may attract a charge, there are charges involved in setting up a pension fund to accommodate drawdown and ongoing charges to manage that fund. These charges and their impact must also be taken into account when considering using a pension tax-free sum to pay down a debt.
Finally, there is the tax position to consider. There are a number of lump sum/income options associated with drawdown each with their own tax implications and it is important to plan how and when income/pension lump sums will be taken. The tax implications may be complex but are a key element of the decision making process.
An initial quick calculation may give the impression using a tax-free pension lump sum to pay down debt is an appropriate way forward but when the implications are considered the situation becomes much more complex and it is important to take appropriate advice.
The information in this article does not constitute financial or other professional advice. You should not take action on the basis of this article without seeking regulated independent financial advice that addresses your specific circumstances. Any tax treatment depends on the individual circumstances of each client and this article represents our interpretation of current legislation and HMRC practice as at the date of publication. These may change in future.