This article is therefore not specific to your pension fund, but if you own an Income Drawdown contract the principles and rules discussed below do apply to you, and you should consider them carefully before taking action.
While we will help you manage your pension fund how you want and in line with the new rules, we would not be doing our job properly if we did not make you aware of the pitfalls and tax traps that now exist. We will therefore deal with these first.
While the rules that come into effect from 6th April 2015 make some radical changes, there are equally a number of rules that have not changed. Perhaps the most important is the way that money you take from your pension is taxed – there have been no changes to the taxation of your pension fund, and people who take big lump sums (or even all of their pension fund) in one go, may be surprised to discover that they have just given thousands of pounds of their money to the taxman.
The golden rule that applies now, and will apply equally in the future, is that only the first 25% of your original pension fund will come to you tax free. The remaining 75% (no matter how you take it) will be subject to income tax.
Many of our customers originally came to us so that they could take the tax free element of their fund only, thereby leaving the taxable 75% until they were older or retired (and likely to be subject to a lower rate of tax).
If you have previously taken your tax free lump from your pension fund then any further income or lump sums you take from it will be subject to income tax.
Any sums you take from your pension fund over the tax free allowance will be subject to tax at either 20%, 40% or 45%. Even though you are taking a lump sum, it is treated as income by Her Majesty’s Revenue and Customs. This also means that any other income you earn from your normal employment could be pushed into a higher rate of tax as the lump sum is counted as income. As an example this could cause a 20% tax payer to pay 40% tax on their entire income for the year.
This element of the new rules has not been so widely publicised and we believe the Government are expecting quite a tax windfall from unsuspecting pension customers.
Based on current knowledge we believe that, in line with current processes, providers will give customers their requested lump sum less basic rate tax of 20%. In other words a customer who has previously taken their 25% tax free cash, asks for a further lump sum of £20,000. They will only receive £16,000 as the remaining £4,000 will be paid to the taxman. The £20,000 will also be added to the customer’s gross income for the year and will be used to calculate whether the customer needs to pay further tax on the sum.
For the reasons above we are very concerned that many customers will directly contact their pension provider to request that they are paid either a lump sum or possibly all of their pension fund in one go. They may come to regret such action when the tax implications above take hold.
Of course some of our customers will be interested in taking a lump sum from their pension fund. Our role will be to help them take it as tax efficiently as possible – some may be able to pay no tax at all.
If you are going to pay tax, then at least we can make you aware of this before you take action that you otherwise may not have. We may also be able to help you gain an understanding of how much tax you will have to pay on the lump sum and your other earnings.
Even if you do need to pay tax, at least you will have done so knowing the situation first and you would have made an informed decision based on this information.
Finally we should also point out that while the idea of taking a lump sum from your pension may sound very attractive, you will be reducing the money available to you in retirement. If you deplete your pension fund, you may find that you don’t have enough money to live on in retirement.
If you would like help releasing a lump sum from your pension please contact us. We will be happy to discuss your pension fund options and tax position. You can call us on 020 33 55 4827.