Do you know the tax implications of the new pension rules?
Please Note: Information in this blog was current at the time of publishing, but may no longer be up-to-date with current legislation. Please visit our blog for the latest pension articles.
The pension freedoms took effect on April 6, and over 55s now have more flexibility with their pensions than ever before. Money in private pensions can be withdrawn in stages or even taken as a single lump sum. However, only 25% of the fund is tax free; the rest is taxable income and the size of your bill varies by how much you withdraw. The following hypothetical examples highlight the tax implications of the new pension rules.
As these withdrawals are the first ones from the pension funds, the providers will not have been issued an accumulative tax code from HMRC to apply to the payment. The sums are therefore taxed on a month-one basis, which reduces the personal allowance and bands to 1/12th of their normal value until the tax is claimed back from HMRC, as it is assumed that the sum will be received each month. This makes it much easier for an individual to be pushed into a higher tax bracket.
David has just reached state pension age but is also still working.
- David has an annual salary that pays £20,000 per year
- He has already taken his 25% tax-free cash, so any income from his pension is taxable as he is above his personal allowance of £10,600
- He is receiving £5,881.20 in state pension each year
- He puts his pension fund into a flexi-access drawdown plan and withdraws £10,000
- David’s total tax bill for his pension withdrawals is £2,000, in addition to the tax taken from his salary
Julie is 66 years old and no longer working.
- Julie deferred her state pension, which will grow by 10% for each year it is deferred
- Her private pension fund is worth £200,000
- She withdraws 30% from her pension, giving her £60,000
- £50,000 is her 25% tax-free cash, and the remaining 5% (£10,000) is considered taxable income if she is above her personal allowance
- As she has no other income, the £10,000 is within her tax-free personal allowance
- Because of the month-one tax calculation, Julie will pay £1,823.33, but she can claim all of it back as her withdrawal is within her personal allowance. Her tax bill for the year will be reduced to zero
Alan is 55 and still working. He wants to remove money from his pension to invest in buy-to-let.
- Alan is earning £30,000 a year so has used his personal allowance
- His private pension fund is £200,000
- He takes his tax-free cash of £50,000, and a further £100,000 from his pension
- The total taxable income for the year is £130,000, which does two things:
- Pushes Alan firmly into the higher rate tax bracket
- Reduces his personal allowance to nil
- This means that £21,200 of Alan’s income will be subject to an effective income tax rate of 60%
- Alan’s tax bill for the year is £49,883 – almost equal to his tax-free cash!
These examples demonstrate the importance of timing – Julie’s tax bill is zero because she is withdrawing more than the tax-free portion of her pension in a year when she has no other income. Alan has lost his personal allowance and is paying HMRC almost as much as he received in tax-free cash, but if he staged withdrawals over a couple of years he could cut the bill significantly.
The pension freedoms have provided more flexibility than ever, but it’s essential to remember that 75% of a fund is taxable, and can potentially push you into a higher tax bracket. This is one of the reasons that talking to a regulated adviser is important, as they can make you aware of the rules and consequences of decisions.
Are you aware of the tax implications of the new pension rules? Let us know with a comment below.
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Please note the above scenarios are not financial advice. Tax payments are based on individual circumstances and are subject to change in the future.
The details provided in this article are for general information only and are in no way deemed to be financial advice. All of the material is correct as of the publication date, but could be out-of-date by the time you read the article. For our latest information and news, please see our articles section: https://www.portafina.co.uk/whats-new
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