“Whilst the flexibility itself is good news, there is also additional responsibility – and indeed in a recent survey conducted among a sample of Towry clients, 41% said that giving people access to their pension funds to use as they like was either a negative development, or one that they were unsure whether it was positive or negative*. Taking the funds in full will rarely be the best option, not least from a tax point of view.
For example, Mike has a fund of £280,000. Under the new rules he will be able to take all his funds at once, but in return he would suffer a considerable income tax charge.
“Let’s assume, in all examples given below, that:
i) Mike has no other income
ii) the examples are using the proposed income tax rates and thresholds for the 2015/16 tax year
iii) £70,000 is taken as tax free cash – the maximum 25% allowed for an individual”
The remaining £210,000 would be taxed as:
Mike will lose his personal allowance of £10,600 as his income for the year will be in excess of £100,000.
Total tax payable by Mike would be £80,643.
“So Mike would suffer an effective rate of tax of just over 38% (£80,643/£210,000). The rate would be even higher if he has other income.”
Reduce your annual income to mitigate your tax bill
“If Mike took the same fund out over a number of tax years he could keep his personal allowance, and not pay any higher or additional rate tax at all. At current tax rates it would take Mike another five years to do this, as per the below example”:
£210,000 spread evenly over five years gives £42,000 a year. This is then taxed as:
£10,600 (personal allowance) at 0% = 0
£31,400 at 20% = £6,280
The total tax over five years payable by Mike would therefore be £31,400.
“This would equate to an effective rate of tax of just 15% (14.95%) and a tax saving of nearly £50,000, with some straightforward financial planning.
“Of course, this is just one example, and mitigation of tax owed can affect many areas of planning your personal finances. Individual professional advice should be sought.”
Examples of how tax may apply are based on our understanding of proposed/current tax legislation. Whether any tax will be payable and at what level it is charged will depend upon individual circumstances and may be subject to change in the future.
* E-mail survey of 219 Towry clients, conducted December 2014
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