Warning: You could buy the taxman a Porsche under new pension rules

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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.

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In the new pension rules from April 2015,the restrictions that prevented people from withdrawing money from their pensions were removed. People with qualifying schemes are able to take as much as they want and are eligible for pension release at age 55. It’s even possible to withdraw the entire fund. This is not always a good idea though, as the tax bill can be large – taking enough to buy the fabled Lamborghini could gift the taxman enough for a Porsche.

One of the perks of pensions is tax relief, which is applied to both contributions and growth. Instead of tax being deducted on the way in, it is taken when withdrawals are made.

It’s still possible to take 25% of the fund as tax-free cash from the age of 55 (known as pension release), but any further withdrawals are taxed at the individual's marginal rate. 

As the rate of tax is based on each individual, rather than a flat rate, the amount due can vary significantly. For example:

  • If you have no other income and withdraw less than the personal allowance, you should not owe any income tax for that year
  • If you are a basic-rate taxpayer and withdraw a sum from your pension then you will pay 20% tax on it, provided the withdrawal does not put your annual earnings into the higher-rate bracket. If it does, you will pay 40% on any amount above the threshold
  • If you are a higher-rate taxpayer, pension withdrawals will be taxed at 40% if they do not exceed the threshold, at which point 45% tax will be applied on any sum over the limit

How punitive this bill can be depends on a number of factors. In a previous post, “Do you know the tax implications of the new pension rules?”, we provided three hypothetical examples of what actions could lead to certain tax bills, one of which was Alan:

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!
     

Whether these rates will act as a safeguard against people taking lots of money from their pensions in one year depends what they want the money for, but a YouGov survey found that 56% of people had a change of heart about emptying the fund after learning of the tax implications, and 68% did not think the government had made the tax charges clear enough when announcing the new pension rules.

Would a large tax bill put you off emptying your fund? Let us know with a comment below.

Call 0800 304 7288 for a friendly chat about your pension

*Based on a £50,000 sum growing at 6% annually before charges of 0.5% and 1.5% are applied.

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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