50-55 year olds pension planning

From April 2010, the earliest age you will be able to draw funds from your pension will increase from 50 to 55. This means that if you are 50 today, you could take the tax free lump sum from your pension, and either take an income from it, or defer that to a later date. From April 2010, you'll have to wait until fo anohe 4 1/2 years.

But why would somebody want to start to take their pension fund so early? Lets run through an example. A gentleman has £400,000 in his pension, and a £100,000 mortgage fixed at 5%, with 10 years remaining. He chooses to take the 25% tax free lump sum, but defer taking an income until 60. This enables him to clear his mortgage outright, as coincidentally, the tax free lump sum is £100,000. As he has no mortgage to pay, he now has an extra £1079 per month to put into a pension. With tax relief of a higher rate tax payer, this would be grossed up to £1,798 per month. Starting to sound good.

If he could achieve 5% growth after charges on this fund between now and retirement, and increase the contributions in line with average earning each year, this extra contribution of £1798 per month would have grown to just shy of £350,000, whereas had he left the £100,000 in his pension, it would only be worth £179,000. Not a bad way to enhance his retirement planning. In the mean time, the remaining £300,000 would also have grown to £537,000.

So why has clearing the £100,000 mortgage provided such an increased fund. In effect, you are getting the tax relief twice. When the funds were originally put into the pension, they received tax relief at his highest marginal rate. Although you cannot recycle the tax free lump sum directly back into the pension, by clearing a mortgage and then funding from income, you are clearly not recycling the same funds. As such, when the new funds are invested into the pension, they are awarded tax relief all over again.

There are a few instances where this cannot be done, but in the main, this makes good financial sense, if done at the right time, for the right people. Those aged between 50 and 55 will lose the ability to do this in April next year, so if this sounds like you, it may be worth considering this now.

So its not all doom and gloom about pensions after all! Make hay while the sun shines!