A huge change in the way people fund their retirement is expected following the Chancellor’s well reported ‘pension revolution’. From 5th April this year, millions of people reaching retirement age will be able to spend their pension pot in any way they want.
The move will remove the requirement on many people with defined contribution pensions to buy an annuity (a financial product that guarantees an income for the rest of your life). The Government says that the overhaul will give retirees more flexibility to do what they want and savers will have freedom to do as much or as little as they want with their pension.
But what do these freedoms mean in practice and what are the tax implications?
New lump sum alternatives
The new pension rules allow for a variety of ways to take a lump sum from your pension fund and each has different tax consequences. But what factors should you consider before taking your money?
NB The new uncrystallised fund pension lump sums are referred to as UFPLS.
Lump sum options
After the 5th April these are the options that are open to you along with the key tax consequences for each:
Option 1 – Withdraw the whole of your fund.
75% will be taxable as income, which means depending on how large your fund is and how much other income you have, a large chunk could go in tax at the 40% and 45% rates. Income or gains you make from the money after withdrawing it, e.g. interest and dividends will be taxed in the usual way. Whatever’s left after income tax will be part of your estate for IHT purposes.
Option 2 – Use a UFPLS and withdraw as much or as little as you want with the option to take more lump sums when you want.
75% will be taxable as income, the balance of the money will remain in your pension fund and any income or gains generated by it is tax exempt. The money left in the fund will be outside your estate for IHT purposes.
Tip UFPLS allow you to manage lump sums tax efficiently. For example, if your business had a poor year and you knew your income was going to be less than the basic rate band you take a UFPLS to make use of the basic rate band.
Tip UFPLS will be available from pension funds which, because of their rules, don’t currently offer an income drawdown option. That is, taking regular money as income from your fund without buying a pension.
Option 3 – Take the pension commencement lump sum, which can be up to 25% of your fund.
It will all be tax free, anything you draw after that will be taxable as income. The balance will remain invested in your pension and any income and gains are generated in a tax efficient environment. If you die before the age of 75 the money left in the pension fund will be outside your estate for IHT purposes and will pass tax free to your beneficiaries. If you should die after 75, on receipt of the fund your beneficiaries will pay tax at 45%. Please note, in 2016/17 this will change to the beneficiaries’ marginal rate of tax.eneficiaries’ marginal rate of tax.
More than one fund
The lump sum options apply to each pension plan. So if you have two or three you could use different options for each. This potentially creates even greater flexibility and tax efficiency.
Tip a way to take advantage of these reforms and minimise the tax payable:
Withdraw the money slowly so that you minimise the tax paid, and then put the money you have taken out into a tax free ISA. Everyone has a £15,000 ISA tax free allowance, so a husband and wife could put £30,000 of the money taken out of a pension into an ISA, ensuring that when they want to draw it down later there won’t be income tax to pay. However, you should seek the appropriate financial advice as everyone’s circumstances are different.
Do I have to retire to take the money?
No, you can be 55 years old and in work, receiving a salary, and be allowed access to your pension. So if, for example, you have a small defined contribution pension pot from a former employer and you want the money, you can take it as a single lump sum or draw it down over several years, even if you are in work and paying into your company’s pension scheme. The same rules apply – 25% of each drawdown will be tax free, with the rest liable for tax at your marginal rate.
To discuss your options and the tax implications for you just get in touch with JRW’s Financial Advisors Jim and Mike, telephone 01450 372267.
JRW Financial Services Ltd is authorised and regulated by the Financial Conduct Authority.