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Financial planning: Raid your pension in haste and repent at leisure?

Or why it might be best to take money from your ISAs first

It is now popular to take cash from a pension whilst you still work. But the complex rules around pensions mean this may not be the best thing to do, especially if you have ISAs as well. Let’s take the example of Jo who is 56 and wants to start working four days a week for a better quality of life.

Jo has a small mortgage which she has been making over payments on. Jo has worked out that if she pays off her mortgage she can work one day a week less and have the same amount to spend. She has a pension and an ISA. Her friend Mary has taken tax-free cash from her pension and Jo wonders whether she should do the same?

If Jo just takes the cash lump sum from her pension there is no income tax to pay. The same is true if she uses the money in her ISA. However, if Jo takes money from her pension the amount she can then contribute is limited to £4,000 a year. Jo is in a generous pension scheme where her employer makes higher contributions for older workers, so she will pay a tax charge on the amount over £4,000 a year.

Things get more complicated when Jo thinks about what might happen if she dies. At the moment Jo can pass on her pension fund (before her 75th birthday) to her son Mike, outside of her estate without any tax on her death. Jo’s ISAs are in her estate and (because she has a large house) would be passed on to Mike after 40% inheritance tax.

If Jo takes all the tax-free cash from her pension and then dies, any withdrawals Mike makes will be taxed as income. So if he takes the whole pension fund he will pay a lot of tax. Jo is not planning to die any time soon, but she can see that it makes sense for her to draw the money out of her ISA before her pension.

Warnings: This post makes general points about the taxation of pensions and ISAs. As Monty Python said “We’re all individuals!” Do not assume the conclusions apply to you. If you are considering drawing benefits from your pension we recommend you take independent financial advice. This post was written in response to the Autumn Statement in November 2016. Tax rules are regularly changed and may be out of date by the time you read this post.

Investment: Why should I invest?

When you invest your money, you should be prepared to accept that the value of your investment may go down as well as up in the short-term. So why would you invest rather than save? Indeed, there are some occasions when you should NOT invest:

  • You need to access the money in less than five years.
  • The financial consequences of a loss are too great for you to take the risk.
  • Your tolerance to the ups and downs of investment markets is low.
  • When you have enough cash and can afford NOT to invest.

But most of us cannot afford not to invest and exposure to some investment risk is necessary to achieve our financial goals. This is because over time, inflation reduces the purchasing power of cash (especially after tax and costs).

To make your money grow faster than inflation you need to invest some of your money in growth assets, like company shares.

But this also means having to accept that your investment may go down as well as up over short periods. Getting the right balance between investment risk and reward is crucial.