One step closer to the pension advice allowance

Plans are taking shape for the pension advice allowance, to encourage more people to seek independent advice on their retirement choices. It is expected to allow the tax-free withdrawal of £500 from your pension pot before you reach 55. Here’s how it could work in practice.

On the day you turn 55 years old, you can access your pension savings. You don’t have to yet, but you can. However, as that day approaches, you face a dilemma. You’ve heard that there are many different ways to access your pension; you’ve heard about big potential tax bills and long-term risks, and you want to make the right choices. You’ve read about how important it is to seek independent financial advice on this major life decision. But to take proper advice costs money – and until you access your pension, you don’t have that money to spare.

Back in April 2016, the Chancellor proposed a solution to this chicken-and-egg problem. Anyone with a defined contribution pension would be able to draw out up to £500 from it before reaching 55 (which otherwise is the earliest you can access a pension pot). The sum would be tax free, and would have to be spent on FCA-regulated pension advice.

The Treasury has now published a consultation paper on this ‘pension advice allowance’, which is now expected to be become available from April 2017.

What’s new about the pension advice allowance?

The allowance will be in addition to the tax-free 25 per cent lump sum that you can already withdraw from the age of 55 – it does not count as part of that lump sum.

Although it’s already possible for your provider to withdraw money from your investment product (such as a pension pot) to pay for financial advice, this only applies to advice on specific products. What makes the allowance different is that it is intended to be used on fully independent, whole-of-market advice covering all the pension products you hold. As such, it should represent much better value.

The exact age at which you’ll be able to take your pension advice allowance is yet to be determined – all we know at this stage is that it will be before you reach 55.

Will it be enough?

Full advice on your choices at retirement is likely to cost considerably more than £500. The cost of pension advice will vary depending on the size of your pension and the complexity of the advice, but a useful rule of thumb is that it’s likely to cost between 1 and 2 per cent of the total value of your pension pot (for smaller pots it may be nearer 3 per cent).

Clearly, the aim of the allowance is to ease the one-off cost of financial advice, rather than pay for it outright. Remember too that most of the £500 is your money anyway – for a basic-rate taxpayer only £100 of it is a ‘gift’ from the government, in the form of tax relief. Nevertheless, for a lot of people an extra £500 may make the difference between getting the advice they need and trying to proceed without it.

Employer-arranged pension advice

Some employers offer an allowance towards pension advice as an employee benefit. The tax exemption granted to employers for this is £500, and this can be used in conjunction with your personal advice allowance.  If your workplace provides this benefit, then from April 2017 you will have access to up to £1,000 of tax-free money to spend on pension advice.

The pension advice allowance in action

Here’s an example of how the new allowance might work.

Craig will turn 55 in a few years’ time. He doesn’t plan to retire yet, but does hope to start drawing his pension so he can reduce the hours he works. However, he is worried about taking decisions now that he might regret in years to come, such as when he enters full retirement or reaches old age. For this reason, he wants to take full financial advice at the outset.

Craig has several pension pots currently totalling around £250,000 (one of the things he wants to ask about is whether he should combine them into one). He finds a financial adviser through the Unbiased search and at his initial free meeting discovers that full pension advice for him will cost in the region of £3,000.

He withdraws £500 from one of his pension pots as his pension advice allowance. As he is still a higher rate taxpayer, this immediately saves him £200 in tax. He is also entitled to £500 worth of financial advice through his workplace benefits. This gives him a total of £1,000 to spend on advice – £700 of which is effectively ‘free money’. However, Craig must still find the remaining £2,000 of his adviser’s fee from his other savings.

Is it worth it? The value of advice

In spending this money on advice before accessing his pension, Craig hopes to save much more than this over the course of his retirement. His adviser will help him make the right choices when first accessing his pension, and also build a plan to cover the whole of his retirement. He can expect a range of benefits, including:

  1. A potential boost to the overall value of his pension
  2. The right product types to suit his income needs, both pre- and post-retirement
  3. The right mixture of flexibility and security
  4. Reassurance that his pension savings will last as long as he needs them to
  5. The best-value products on the market (choosing the right annuity alone can save thousands over the course of a retirement)
  6. Less of his pension lost to tax
  7. A stress-free process, with all the administration taken care of.
  8. Protection from the risks of pension fraud.
  9. Anticipation of potential risks, and plans for managing them.
  10. The confidence that he has taken independent, regulated advice from a specialist.

More details of the pension advice allowance are expected to be announced before its introduction in April 2017. In the meantime, you can find out the current state of your pension with a free pension check from a regulated adviser.

This article was first published by unbiased on the 12th September 2016.