Take more that 25% Tax Free Cash

 
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This page is full of information on how to take create an additional Tax Free Lump Sum from your pension.

By reading this page you will gain a good knowledge of what needs to be done, if you want to take advantage of this approach - and the benefit of doing this all in one policy rather than having to hold multiple policies.

 
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We make it easy for you to release a tax free pension lump sum from your fund. We do it by giving you excellent customer service, explaining everything you need to know and doing all the work for you.

How to take more than 25% tax free cash from your pension fund –
or how to take more than one tax free lump sum

When talking to customers many of them tell us that they would rather take all of their pension fund as a lump sum. For a few customers, recent changes to pension rules will allow them to do just that. However the majority will still be tied to the current rules which will dictate that they can take 25% of their fund as a tax free lump sum but must still take an income with the majority of their pension fund.

This article will show how a customer can use an income drawdown fund to take more than 25% of their pension fund tax free by recycling income in the drawdown and taking a second tax free lump sum at a later date.

Before we discuss this further there are two important points to make.

1. We are only discussing the income drawdown contract that we use and how it operates. Not all drawdown providers operate in this fashion and we cannot guarantee that other product providers will allow you to operate their contract in the way discussed on this web page.
2. Nothing on this page, or on this website, is personal financial advice and recommendation. We are not recommending customers take the action described below, and it is for individual customers to decide if this course of action is appropriate for their needs.

 

Legality and Taxation

Her Majesty’s Revenue and Customs will not allow customers to recycle / re-invest money taken as a tax free lump sum from a pension fund back into a pension fund. This is because a customer will receive double tax relief on the same contributions.

It is however perfectly acceptable to re-invest / recycle pension income back into a pension fund. This is because the income from a pension fund is liable to income tax, even if there is no or very little tax charged. This creates the opportunity to generate a further tax free lump sum from the same pension fund in the future.

For customers who are contributing less than the annual allowance (see table on right) into their pension fund – including the recycled income - the exercise of reinvesting income back into their pension fund is tax neutral.

In other words any tax you are charged equals the amount of tax you can reclaim. We will show an example of this later.

People who pay higher and additional rates of tax, will receive any tax relief over the basic rate of 20% by a change to their tax code and / or an adjustment to the tax they have to pay via a tax return.
 
Pension Annual Allowance

The annual allowance for pension contributions is the MAXIMUM amount you can invest into a pension plan and receive tax relief.

While it is possible to contribute more than this amount into a pension, you will only receive tax relief on those contributions that are equal to, or below the annual allowance.

For the purposes of income recycling, any regular contributions and any recycled income from a pension plan all contribute to the annual allowance.

The allowance is currently £40,000 per annum.

Suitability

While it is for each customer to decide for themselves if income recycling is suitable for their needs, it is likely to be more suitable for customers who are happy to take all of their initial 25% tax free lump sum before retirement and who have 5 years or more before they plan to retire and don’t immediately need income. They are happy to receive a reduced income in retirement in exchange for a larger tax free lump sum.

Such customers will have no need for an immediate additional income from the fund. In other words they can live on the income they are receiving from say an employer, and don’t yet need to live on the income that will be produced by their pension fund.

This will only be financially worthwhile for customers who are contributing less than the annual allowance into their pension (currently £55,000 per annum in 2013). This includes any amount recycled from the drawdown.

High-rate and additional rate taxpayers may find this solution attractive, even if they have a very short period to retirement.
It is unlikely to be suitable for customers who are contributing more than the annual allowance into their pension fund, as they will not
receive any tax relief on the contribution.

This is unlikely to be a good idea for customers with small pension savings who will rely on their pension fund to provide an income throughout their retirement.

How does Income Recycling work ?

It may be best to explain how this works by looking at a simple example. An income drawdown contract from our selected provider is used in the example. This contract will enable the customer to manage everything in just one pension policy and they will not have to worry about running several different plans to achieve the outcome.

For more information on income drawdown, please see the income drawdown pages on this website or call us on 020 33 55 4827.

More Tax Free Cash Study Roesmary Income Recycling Case Study Flexible Case Study
To better understand this example, we will assume that Rosemary’s pension fund will have no growth or losses for a 10 year period. The overall value remains the same at all times.
 

In reality she would hope to achieve growth on the pension fund.

She is a basic rate tax payer (example based on 2013 – 14 tax rates).

It is Rosemary’s 55th birthday and her pension fund is worth £100,000. She decides to take the maximum tax free lump sum from the fund of £25,000. She is left with £75,000 still in her pension fund. We call this the crystallised pot.

She has no need to take an income from the fund and she doesn’t plan to retire for another 10 years when she is 65.

She has other pensions and investments and therefore feels she would like to take another tax free lump sum from this fund at the expense of a lower income when she is 65. Ironically, to do this she needs to take the maximum income from this fund now ! For the sake of this example we will assume the maximum income she could take now is £3,000 per annum or £250 per month.

On the 1st of each month therefore she takes £250 from the crystallised pot. This amount must be paid into her bank account. It is paid less tax of 20%, so she receives £200.

On the 10th of the month she has a direct debit of £200 taken from her bank account and paid back into her pension fund. She will receive basic rate tax relief (20%) on her pension contribution so the £200 is grossed up to £250 – exactly the same as was originally taken out of the pension as monthly income.

This new contribution is placed into an un-crystallised pot.

Therefore after one month her pension policy is made up as follows :

 
 
  Crystallised pot £74,750
(£75,000 less one payment of £250)   
  Un-crystallised Pot       £250
(first month’s recycled income)   
  Combined value £75,000
 
 


After 10 years (120 months) at retirement Rosemary’s pension policy looks like this :

 
 
  Crystallised pot £45,000
(£75,000 less 120 payments of £250)   
  Un-crystallised Pot £30,000
(120 month’s recycled income)    
  Combined value £75,000
 
  Please Note : As we are assuming no investment risk, the overall value of Rosemary's pension remains the same £75,000 we have simply moved money from a crystallised pot in to an un-crystallised pot over time.  
  Rosemary cannot take a further lump sum from the crystallised fund but can from the un-crystallised fund worth £30,000. She therefore takes the maximum of £7,500 – which is paid free of income tax.

She has therefore taken £32,500 tax free (£25,000 at age 55 + £7,500 at age 65) from a pension fund of £100,000. In other words she has achieved a tax free lump sum of 32.5% and not the standard 25%.

This is a simple example which explains the basic concept in recycling income in a drawdown contract. The example assumes no investment risk. If Rosemary had managed to achieve 4% annualised growth on her pension policy, then at age 65 the un-crystallised fund would have been work £37,459 instead of £30,000. She would therefore have been able to take a tax free lump sum of £9,364

 
Flexible Drawdown bottom

Tax relief for people on higher rates of tax can make this approach even more attractive; please call us for more information.

Other pages on this website may look at more complex scenarios and tax situations.

If you are interested in income drawdown recycling or want to understand it better please call us on 020 33 55 4827 and a qualified member of the team will explain further and answer any questions you have.

If there are any specific case studies that you think would be of help to other customers, please let us know.


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