Posted on 9 December 2014
In April 2014 the Chancellor unleashed the pension regulations and created a mini tidal wave of panicked pension fund managers who predicted doom and gloom for the pension industry.
Then, there were the visions of the future where all pensioners-to-be would be hurrying in stampede to cash on their life savings and buy Ferraris, properties and world cruises.
And then, there were those who have started to look at their pensions from a fresh perspective as a suitable vehicle to help them pay off the debt on their mortgage. In a mortgage market where the Interest Only mortgages are seen as high risk by the Financial Conduct Authority, a suitable repayment vehicle is the key to a lender’s lending book, or is it?
I have caught up with Phil Jenkins, a pension specialist with our sister company, Towergate Financial. Phil has kindly agreed to decipher a few myths or truths about the newly promised pension freedoms.
As I understand it, the new pension rules allow people to cash in their whole pension fund on retirement, is this correct?
The proposed changes are a very positive step in allowing individuals control of their retirement arrangements. From the new tax year in April 2015 retirees with defined contribution pensions have a variety of choices to access their pensions. One of the options is to take the total value of their pensions as a lump sum. If they take the full value of the pension pot, 25% of the lump sum will be tax free. This is known as the Pension Commencement lump Sum (PCLs). It is vital to remember that any additional withdrawals on top of the (PCLs) will be added on to an individual income in the current tax year, and therefore will be assessed for income tax accordingly.
Anybody considering accessing their pension should consider the impact of this additional tax – as well as considering that if they’ve taken their entire pension fund as a lump sum, then how do they intend to support themselves throughout retirement?
So are all pension schemes subject to the same rules?
No. These changes apply to defined contribution pensions schemes. It is proposed that the government will apply a ban on retirees wishing to transfer their final salary pensions (or defined benefit schemes), if employed in the public sector. However, in its recent update the Government confirmed transfers out of private sector final salary schemes, to defined contribution schemes, will still be permitted after 2015. Anyone transferring more than £30,000 should really take independent financial advice.
The possibility of taking a lump sum means some people may consider using their pension to repay the capital on an interest only mortgage – what are the dangers associated with this course of action?
There is always an inherited risk if a mortgage is not taken on a repayment basis. If you’re not paying off the capital through regular repayments then you need to know that you can pay the capital off at the end of term. Using a lump sum from your pension to pay off the capital sounds like a great idea, but you need to be aware of the risks before you make any decisions.
Firstly, a pension is just a wrapper, the funds held within the pension will need to be invested. Therefore the pension will be subject to both investment risk and the values will fluctuate on a daily basis. If the mortgage repayment term coincides with a downturn in asset prices / fund values there may not be sufficient to repay the borrowing. Secondly, regular monitoring of the pension contribution amounts is required to ensure that the pension fund is on track to achieve the mortgage borrowing. If a loss of income occurs, say through illness or unemployment then potentially shortfalls in contributions will occur. And lastly by relying on the pension to pay off outstanding debt, how will a retiree support themselves in retirement and have sufficient income to maintain their standard of living?
You do of course always have to remember that future governments may change the rules!
For further pension and investment advice Phil Jenkins is available on firstname.lastname@example.org or come and meet him next time when you see your mortgage broker.
0844 346 3672
This article is for information only and does not constitute advice.
Please obtain professional advice before taking out a mortgage.
Your property may be repossessed if you do not keep up repayments on your mortgage, or any debt secured on it.
Please obtain professional advice before making financial decisions. Please note that we are not tax advisers – please speak to your tax adviser for further information on tax liabilities.
All information is correct at date of publication.
The blog postings on this site solely reflect the personal views of the authors and do not necessarily represent the views, positions, strategies or opinions of John Charcol. All comments are made in good faith, and John Charcol will not accept liability for them.