“Is your pension pot a devil in disguise?”

1st February 2016


Frazer Wilson, senior consultant at Thomas Miller Investment, examines the opportunities and pitfalls in pension flexibilities…

Many years ago, Elvis sang the famous words “you look like an angel, walk like an angel, talk like an angel, but I got wise….”

With the end of the tax year around the corner, the press is inundated with articles about pension planning. Much has changed recently when it comes to pensions and while pension pots have potentially become a “tick all the boxes” asset, you need to be careful, or otherwise things can turn nasty with significant tax consequences if you get it wrong.

So just remember that the King “got wise” just in time. Be like the King.

The new pension flexibilities increase the income options available and make a pension much like any other savings account, albeit you can’t touch it until age 55.

However, cashing in a pension could have drastic tax consequences as only 25% will be paid tax free, with the remaining 75% taxed at your highest marginal rate.

An individual with an income of £25,000 who cashes in a £50,000 pension would suffer an additional £11,523 tax bill (based on 2015/16 tax rates). A quirk in the legislation means you’d actually pay £15,323 in tax when the funds are withdrawn, and then have to reclaim the difference.

Following the rule changes introduced last April, the idea of using pension assets for Inheritance Tax planning can be attractive. Your pension pot can still be used to provide an income, but it’s now possible to pass the fund down to your chosen beneficiaries, without it being subject to inheritance tax, or maybe any taxes at all.

Using savings and investments to fund your retirement income, rather than your pension, can reduce the assets which might otherwise be subject to a 40% Inheritance Tax charge, whilst preserving your pension funds for the benefit of your nearest and dearest.

The welcome announcement that those who pass away before age 75 can leave their pension fund to their loved ones tax free is all very well, but unless it is spent, it will simply increase the estate and potential inheritance tax liability of the beneficiary.

However, opting to retain an inherited pension in a pension wrapper avoids this.

Passing away after age 75 is less favourable; withdrawals from the inherited pension will be taxed at your beneficiaries’ marginal rate, but this doesn’t stop them retaining the funds in a pension wrapper and taking an income as and when needed.

There appears to be no limit on how often the pension can be inherited; inter-generational estate planning may no longer be the preserve of the very wealthy.

But be aware that many old style pensions do not offer these flexibilities (both at retirement and on death), so make sure your pensions are structured in the right way. Most importantly, given the significant rule changes, make sure those whom you wish to benefit from your pension funds do.

The administrator of your pension fund is not bound by your will, so make sure you complete or update an ‘expression of wish’ form, which can be obtained from your pension provider.

Finally, for those with larger pension pots, or who are looking forward to a guaranteed income from their final salary pensions, a tax charge of 55% for funds over £1m will concentrate your mind.

When it comes to the final salary calculation, you’ll need to multiply your projected income at retirement by 20, adding any tax free cash, to see how close you get to the £1m level. Don’t forget to add any other pension pots to this figure to see if you’re close to the limit.

With the number of options available, advice is always key. Make sure you seek advice from the right people and get your skates on. Don’t forget – “It’s now or never…..”

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