I am a 58 year-old looking to retire as soon as possible. I am mortgage and debt free, but only have around £6,000 in my company pension.
I had an £84,000 pension pot but cashed it in when I was 55 to pay off debts. I ended up with £63,000 after paying tax on it.
Since then, I have come into an inheritance so I now have around £420,000 in a bank savings account and have rejoined my company’s pension scheme.
Is there any way I can use, save, invest or top-up my pension to get me a monthly income of around £1,500-£2,000 a month so I can retire?
Retirement ambition: Can I retire at 58 with a pension and savings totalling £426,000?
Gary Smith, chartered financial planner at Tilney, replies: Any effective retirement plan typically involves accurately assessing your spending requirements in old age, and then evaluating if your assets will last long enough to meet them.
Receiving an inheritance often enables people to retire earlier, although in this case your ability to use your inheritance to fund pension saving is going to be limited, for reasons I will discuss below.
I have assumed that your company pension scheme is a ‘defined contribution’ plan, since these are now prevalent in the private sector.
Can you use your inheritance to top-up pension fund?
As you have previously accessed a pension, using the uncrystallised funds pension lump sum (UFLPS) option, it is highly likely that you will have triggered the money purchase annual allowance.
What is UFPLS and the MPAA?
The uncrystallised funds pension lump sum is the official description for retirement savings sitting in a pension scheme and not yet used to buy an annuity or invested in an income drawdown scheme.
Making withdrawals beyond the 25 per cent tax-free lump sum triggers the money purchase annual allowance, which refers to the reduced annual allowance of £4,000 that kicks in after you have done this.
The annual allowance is the limit on how much you can put in your pension each year and still get tax relief on contributions. This is Money
In plain terms, this means you and your employer are restricted to putting a maximum of £4,000 – including pension tax relief – into your pension every tax year from now on.
If you put in more, HMRC will make you repay the tax relief via something called an annual allowance charge.
It is too late for you, but it is worth pointing out for the sake of other readers, that if you had previously only taken a 25 per cent tax free lump sum – known as the pension commencement lump sum – you would have not triggered the MPAA.
That would have let you use your inheritance to top up your pension at a much higher rate.
You could have contributed your available annual allowance – £40,000 unless you are a very high earner, or the equivalent of your annual salary if that is lower – into your pension each tax year until you started drawing further on it.
Furthermore, fully encashing pensions that have a value below £10,000 would also not trigger the MPAA, although there are limits on how many times this can be done.
What else can you do to fund early retirement?
So, topping up your pension by a total of £4,000 a year is certainly not going to require your entire inheritance.
Your inheritance can be used to allow you to retire early though, as there are many alternative options available to you.
Gary Smith: ‘Receiving an inheritance often enables people to retire earlier’
1. Check your state pension: One area that is often overlooked by retirees is establishing what state pension they will receive, and if they have any shortfall in their entitlement.
If a shortfall does exist, using some of your inheritance to purchase additional years towards the state pension could be very effective.
The current maximum state pension is £168.60 a week, or £8,767.20 a year, and, if you are married your combined allowances would go a long way to meeting your expenditure requirements, although you should also clarify the age from which you will receive your entitlements.
You can check what state pension you will get here, and find out about paying voluntary contributions here, but you should liaise with the Department for Work and Pensions directly to see if this option is available to you. You can also check your state pension age here.
2. Plan ahead if you want to keep your inheritance in cash: As you require a net annual income of £24,000, simply holding the full inheritance in savings accounts may put your objectives at risk.
Indeed, if we are optimistic, and assume that you are able to secure interest of 2 per cent a year, this would only provide £8,400, leaving a shortfall of £15,800 to find.
However, if you do establish that you and your spouse will receive maximum state pension entitlements, you might be happy to see your capital fall in value initially, as the amount you will need to generate from your inheritance will reduce in later years.
If retaining your inheritance in cash-based accounts is your priority, then spreading it among different banks is advisable, as your savings are only protected, for each bank, up to £85,000 via the Financial Services Compensation Scheme.
Alternatively, you could access accounts via National Savings & Investment, as deposits in those are fully protected by the Treasury.
3. Consider if you want to invest your inheritance: If you want to invest some of your inheritance, then you can put the money in investment funds (known as unit trusts and OEICS) or investment trusts, and shelter up to £20,000 a year per person from tax within Isas.
How to invest your pension and live off it in retirement
A 12-step starters’ guide – and the pitfalls to avoid – read more here.
Via these types of accounts, you could invest in a diverse range of assets – shares, company and government bonds, commercial property and so on – that are managed in line with your attitude to risk. If you decide to invest large sums, help should be sought from a financial planner or adviser.
4. Buy an annuity: Although you cannot invest your inheritance into a pension, you could still use these monies to purchase a guaranteed income, using a purchase life annuity plan.
Under this type of arrangement, you could invest £400,000 and, in exchange, you would receive a guaranteed income of £10,800 for the rest of your life. This option wouldn’t enable your objective to be achieved and it would result in you not having any access to this capital.
How else can you prepare your finances for retirement?
Prior to deciding what to do, I would encourage you to consider how much you need to retain in instantly accessible cash accounts.
As well as holding an emergency fund, you also need to factor in any anticipated expenditure you might have during the next three to five-year period – purchasing a new car, home improvements, luxury holidays, and assisting children financially, for example.
Any money you want for these purposes should probably be retained in cash-based accounts to avoid falls in value from investing in risk-based assets.
Another point to consider is inflation, and how this will impact upon your long term ability to meet your expenditure requirements.
Whilst you have identified that you initially require £2,000 (net of income tax) per month, if we assume an annual rate of inflation of 2 per cent, your monthly income would need to increase to £2,400 after 10 years, £2,900 after 20 years and £3,200 after 25 years to maintain the current purchasing value.
If you don’t increase your income, then your spending power will effectively reduce in your retirement.
One piece of good news is that the state pension currently does increase by at least 2.5 per cent a year, under a government policy called the ‘triple lock’, thus maintaining its purchasing power.
In summary, your inheritance should enable you to be in a position to retire, although I do anticipate you will have to use some of your capital to meet your expenditure requirements in the early years, with this offset once you qualify for your state pension.
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