Should I stop paying into my pension?

25 June 2013

Q

I am 59 and semi-retired as a landlord of an industrial complex, which returns in excess of £60,000 a year. I have a pension fund of £160,000, which I still pay into at a rate of £400 a month net. On present predictions, if I purchased an annuity I would have to live for about 21 years to have any chance of seeing my money back, which taking into account my poor health is highly improbable. I was hoping to take income drawdown, but it appears that I have to have an alternative guaranteed income of £20,000-plus for me to be allowed that option. I am at a loss whether to stop paying into my pension and what to do with the pot. Any suggestions would be welcome.
From
JS/Ivybridge

A

The main benefit of paying money into a pension is tax relief on contributions. Assuming you're a higher-rate taxpayer, a £400 net contribution will automatically be grossed up by basic-rate tax to £500 and you can reclaim a further £100 of higher-rate tax via your tax return. So a £500 gross contribution ends up costing you £300.

The downside of that is the cash must be used to provide an income, either via an annuity or income drawdown, or left alone.

Since you don't need the pension income, perhaps the biggest issue is what happens to the pension fund on your death - it can either be passed as a cash lump sum to beneficiaries or used to provide an income for dependants.

Both scenarios should avoid inheritance tax, but other taxes may apply. Where the pension fund is passed across as cash, a 55% tax will apply if you've already taken benefits or you were at least age 75 on death.

If you were under 75 and no benefits were taken (that is no 25% tax-free cash or income drawdown), the sum can normally pass tax-free to beneficiaries, although any amount in excess of the lifetime allowance, (currently £1.5 million) will be taxed at 55%. Where the pension fund is instead used to provide an income for a dependant after you die, the fund can be passed on tax-free but the resulting income will be subject to income tax as usual.

Find the best annuity rate for your circumstances

Annuity options

Should you decide to take an income, annuity rates are currently derisory, so I can well understand your reluctance to buy one. Since annuities are usually backed by gilts, high gilt prices have taken their toll.

Under standard 'capped' income drawdown, you can take 25% of your pension fund as tax-free cash, then draw an income of between zero and 120% of a pension (based on a single life level annuity) calculated by the Government Actuary Department.The maximum needs to be recalculated every three years if you're under 75 and annually thereafter. Standard drawdown rules apply regardless of any other income you may receive.

If you receive a minimum £20,000 secure annual income for life, via other pensions, and no longer contribute into pensions, you can benefit from 'flexible' drawdown, which removes the cap on how much income you can draw.

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So you could, for example, take the whole lot in one go, although any amount above the 25% tax-free cash will be taxed as income. Sadly, HM Revenue & Customs doesn't count investment income, such as your rental income, as being 'secure', so it won't count towards the required £20,000 minimum income.

Given you mention poor health, you might be eligible for an impaired life annuity. Put simply, if you have a medical condition that could shorten your life, some insurers will offer higher than usual annuity rates to reflect this.

By far your biggest decision is whether to leave the pension untouched so that it may pass as a tax-free lump sum to beneficiaries should you die before age 75 (assuming your total pension funds are below the lifetime allowance).