If you are planning on taking your pension after April, you could save yourself thousands of pounds by familiarising yourself with some of the pension tax rules – to make sure you don’t pay too much. From April, workers over 55 will be able to use their pensions “like bank accounts” and withdraw thousands of pounds to spend as they wish.
More than 200,000 people will cash in their entire pension pot when the reforms take effect, with one in five planning to use their savings to fund a holiday, an Ipsos MORI study has found.
But depending on their income and how big their pension pot is, these savers could face eye-watering tax bills. As calculations by broker Hargreaves Lansdown show (see below), people choosing to take their pensions as cash in one go will pay substantial tax.
If you don’t need to take a cash lump sum from your pension, you could save yourself a big tax bill by choosing to extract money from your pension over a number of years. As with each of the three scenarios to the top right of this page, someone with similar amounts of money could reduce their tax bill by choosing to take lump sums over the course of two, three or four years.
The key to understanding when you could be overtaxed is recognising that money taken from pensions will be added to your taxable income for that period and taxed at your marginal rate.
For example, if you have £30,000 income a year, your marginal rate of tax is 20pc. However, if you cash in a pension pot worth £90,000, even after taking your tax-free lump sum, your total income for the year will be £97,000. This pushes you well over the 40pc tax threshold, which is £41,865 in the 2014-15 tax year. Below this amount you’d be taxed at 20pc for everything above £10,000 – the allowance everyone can earn tax-free.
Billy Burrows, associate director at Key Retirement Solutions, said: “Many people may be emotionally attached to the idea of taking the cash from their pension funds without thinking what they will be doing with the money.
“If the idea is to use the cash to provide an income it might be better to leave the money in the pension fund and take income directly from the pension. It is also much better to buy an annuity from a pension fund than from savings.”
Savvy savers looking to reduce their tax bill can also recycle money they have recently extracted from their pensions by investing it straight back in. For example, if you take out £10,000 you’ll be taxed at your marginal rate – let’s say it’s 20pc. You can then put this straight back into your pension and get 20pc tax relief on it, effectively making the transaction tax neutral. The tax saving comes when you come to take your pension again as you’ll get 25pc of it as a tax-free lump sum.
However, Alan Higham, retirement director at Fidelity, warns the process can be complicated. This is because taking a lump sum means you’ll likely be put on an “emergency tax band”, which will require correcting.
And if you are a 40pc payer in the year you extract the recycled pension, you’ll have to fill in a tax return to claim 40pc tax relief on your pension.
No comments:
Post a Comment