Lowes Magazine Issue 115

PLANNING

Making the right financial decisions in a crisis

MAKING THE RIGHT FINANCIAL PLANNING decisions during and post the Covid-19 crisis is essential to ensure that, as much as possible, we protect our wealth and help it grow again. The impact of lockdown first on the stockmarkets and now on the UK economy is one of the most serious events in recent memory. Certainly, there will be many investors and savers who will never have known stockmarkets to drop as far as they did in March 2020. Even those who experienced the financial crisis 11 years ago may well have been spooked by the recent falls. Stockmarkets have since recovered a little and certain areas such as technology – and the FAANGs (Facebook, Apple, Amazon, Netflix and Google) – have seen considerable interest – a new tech stock boom of which past experience warns we should view with caution. Fear, panic and concerns around income have helped create a situation where people are sucked into making the wrong decisions, some of which could seriously affect their future wealth. It can be argued that it can be not so much what we do as investors and savers but rather what we don’t do which will have more of an impact on protecting our wealth. Taking money from pensions Reduced income brought about by the current crisis, including reduced payments from income funds and cuts and suspensions to investment dividends, has seen many savers and investors who are reliant on that income to maintain their lifestyle, consider drawing lump sums from their pensions. This is done to shore up their finances and, in some cases, to help out others in difficult circumstances. While flexible pensions have made it easier to access retirement savings, there are serious disadvantages and tax traps involved in taking money from pensions, which mean anyone should think carefully about if and how they withdraw money. First, pensions are designed to build a pension pot

for your future. They are one of the most tax efficient savings investments you can make. They work on the basis of accumulation, with capital paid in and returns made and reinvested, which means the money is constantly compounding, with returns building more returns and working for you over the years. Taking money out of a pension fund ahead of when it is needed for its actual purpose, i.e. providing an income in retirement, will reduce the pension’s ability to make money going forward. With recessions in place and stockmarkets volatile, there is no guarantee a depleted pension fund will return to the position it was in when the money was taken out, let alone grow further. This is particularly so if a pension fund is drawn from in the run up to retirement. There are considerable advantages in terms of inheritance planning for retaining money in a pension, as should the pension holder die before age 75 their beneficiaries can receive the pension free of income tax. After age 75, the beneficiaries pay tax at their marginal rate. Removing money from a pension will trigger a tax event, which can seriously deplete the amount received. HMRC considers that pension withdrawals will be undertaken for the same amount every month. So, when a lump sum is taken from a pension, the taxman assumes that same sum will be withdrawn every month and applies the appropriate tax rate to the lump sum – this can see people on standard rate tax paying higher rate tax. The tax can be reclaimed but takes some form filling and months to achieve. HMRC repaid over £166 million in overpaid tax in 2019/2020. In addition, taking money out of any pension held, then limits the individual’s maximum pension contributions per year from up to £40,000 to just £4,000 – again reducing the ability to build pensions savings in the future. As you can see, taking money out of a pension has to be carefully considered, not least in the context of its potential impact on the saver’s future income needs.

8

Lowes.co.uk