How far could a £250,000 pension pot go?
- 29 February 2020
- 15 minutes
• You have to understand your personal financial circumstances and make a series of choices
• The usefulness of £250,000 will depend on how much you will need and how long for
• Professional guidance and advice are there to help you navigate these decisions
If your pension pot totaled £250,000, would that be enough for you to live off? The answer to that simple question is complex as it depends on several factors: your age, health, life expectancy, existing debts, property situation, dependents and previous lifestyle, among others.
We can’t answer all those questions here, but what we can do is consider some of the initial options you have with a total pension that’s worth £250,000.
There are three main options which are shown below in the flowchart. Each is looked at in the following pages.
Let’s assume that you’ve accrued a total pension pot of £250,000 and you’re old enough to draw money from it. At the time of writing, UK legislation allows you to withdraw money from your pension once you are 55 years of age.
With this in mind you have three broad options:
1. Leave the money where it is
2. Withdraw all of the money at once
3. Withdraw all of the money piece by piece over time.
Let’s take these in turn.
Option 1 - Don't withdraw
This deserves serious consideration.
Once you’ve gone through the other options and got an idea of how much income £250,000 could pay, you might be very tempted to leave your money where it is for a while longer.
This leaves your money invested where it has the potential to grow (or fall) in value.
Importantly, though, you can also keep contributing to your pension pot which would allow you to continue to benefit from the tax incentives set up to encourage investments in pensions.
At the time of writing, the broad tax rules that apply to pension contributions are shown in the box to the right.
Now let’s find out what the other main options are, so you can see if they make more sense for you.
Outline of pension tax considerations
Money taken directly from your salary is untaxed
Contributions you make to a Self-Investment Pension Plan (SIPP) could be entitled to a 25% top-up from the government to reimburse income tax paid
Higher tax payers can apply to reclaim additional tax paid depending on the rate of income tax that they pay
Roughly speaking, up to £40,000 (but no more than your total salary) can be contributed to a pension each year (though the previous three years on tax allowance can be added depending on circumstances)
Once your total pension pot reaches £1 million, things start to get more complicated.
Tax treatment depends on individual circumstances and may be subject to change in future
Option 2 - Withdraw all the money at once
There are three ways in which you can withdraw all of the money:
Withdraw all the money as cash
Withdraw some as cash and use the rest to buy an annuity (guaranteed income)
Withdraw all of the money and use 100% of it to buy an annuity.
Withdraw it all as cash
The first 25% of your £250,000 pension pot can be withdrawn without having to pay any tax on it. That’s £62,500, which leaves £187,500 which is taxable. To follow is a hypothetical example to give you an idea of how taxes might be applied on the remaining £187,500.
If you were to pay 0% on the first £12,500, 20% tax on the next £37,500 pounds, 40% on the next £100,000, and 45% on the remaining £37,500, then your total tax bill would be £64,375. Take that off the original £250,000, and you’re left with £185,625.
IMPORTANT: This is a hypothetical example using the 2019/20 personal tax bands. The amount of tax you would pay is dependent on your personal circumstances.
Withdraw some as cash and use the rest to buy an annuity
You can withdraw up to 25% as cash (which is tax-free) and use the rest to buy an annuity, which is a guaranteed income.
The government encourages this by not taxing money you use to buy an annuity. So you could take up to £62,500 tax-free, and then use the entire remaining £187,500 to buy an annuity. Withdraw all of the money and use 100% of it to buy an annuity.
The third option is to withdraw the entire pension pot and use 100% of it to buy an annuity. There is no tax liability on this when you buy the annuity, but the money you receive from annuity payments will be subject to tax. What will an annuity pay?
This depends on a range of factors including these:
Is it a lifetime annuity or just for a fixed number of years?
Is it for one person or a couple?
Is it index-linked so that it rises with inflation?
Do you want money from it to be passed on after you die?
Do you want to take out insurance on it so that you can pass on some money should you die very early on in the life of the annuity?
Not the most pleasant of thoughts, but reality places them upon us.
To get an idea of what an annuity might pay, let’s look at two illustrative examples based on the full £250,000 being used to buy an annuity.
The following quotes and numbers were taken from the Money Advice Service in June 2019, a non-profit organisation set up by the UK government. It provides broad guidance but, obviously, cannot allow for the myriad of variations that apply across individuals.
For illustrative purposes only
Andy, is a healthy, physically average, unmarried non-smoking teetotaller, aged 60, living in Leicester (yes, post codes affect the outcome) paying £250,000 into an annuity.
Andy wants a lifetime annuity i.e. one that will keep paying until he dies.
He has chosen not to have the monthly payments rise with inflation. Instead, Andy will receive the same amount each month.
Andy has no wish to leave money behind in the event of his death. Nor does he take insurance to get a pay-out should he die earlier than expected. He also goes with a fixed payment, i.e. one that does not increase over time to counter the effects of inflation.
The ball-park monthly figure that the Money Advice Service estimates is £935 per calendar month.
Also 60, single and from Leicester, Annie enjoys a glass or two of wine most days, smokes heavily and has heart problems.
She wants her monthly payments to increase over time but also wants some money to be left for her nieces after she dies.
Her £250,000 up-front payment generates an estimated £639 a month.
On their own, her health problems would reduce her life expectancy which might increase the monthly payments she receives as there would probably be fewer of them.
However, the rising value of payments and desire to provide for relatives after her death mean that the initial amount Annie receives is considerably lower than it is for Andy.
Option 3 - Withdraw the money in fixed amounts over time
This is where you would set up regular payments (drawdowns) from your pension pot.
For example, if you drawdown £1,000 every month, £250 of that would be tax-free, while the remaining £750 would be taxable.
This could be beneficial in two ways. Firstly, by taking smaller amounts, you might stay within a lower tax bracket. Secondly, it enables you to leave money in investments which can continue to offer potential growth.
Always remember that stocks can, of course, go down as well as up, so there is no guarantee that your pension pot will grow during this or any other period.
Assuming that your pension pot neither grows nor shrinks during the subsequent months, such a drawdown schedule would give you 250 months of payments. This equates to 20 years and one month.
This sounds OK at first, but inflation is rarely ever zero or below. This means that, with each passing year, the value of that monthly payment buys less and less.
What’s more, as we get older, our health tends to deteriorate meaning that we’ll probably need increasing healthcare or assistance.
As the box shows, care home costs alone are a serious consideration that could quickly eat into that £1,000 a month before tax.
Care home costs
According to the Age UK website in June 2019, the cost for a care home average around £600 a week, while that for a nursing home is over £800 a week. This is a national average, so there are areas of the country where the costs can be higher.
Once a person’s total net worth falls below £23,500, the local authority might step in to assist, but it will have an upper limit on what it will pay.
In other words, you might have to contribute to healthcare costs from your own pocket if your preferred care provider costs more than your local authority is prepared to pay.
If you thought that was a little bewildering, there’s more. Some of the further considerations that you have to bear in mind, and which we will cover in other briefings include:
Other income sources that you might have (e.g. employment or rental income)
Where you are single or part of a couple and what their circumstances are
How much, if anything, you’d like to leave by way of inheritance
Where you want to live in the world
Whether or not you have to meet mortgage or rental payments
Any debt or assets you have
There’s clearly a great deal to think about and some serious choices to be made.
Any views expressed are our in-house views as at the time of publishing.
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Always seek a professional opinion as tax rules can be complex, depend on individual circumstances and are subject to change.
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