Personal PensionNov 18 2015

Understanding at-retirement tax ramifications

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With the new options, came new ways for individuals to be taxed and therefore opportunities for advisers to sit down with clients and discuss the most efficient way forward.

Since the spring, those aged 55-years-old plus can withdraw cash from their pension funds and pay tax at their marginal rate.

In particular, those who die before age 75 can pass on the pension fund tax free, without any restrictions.

When someone dies over the age of 75, the fund can be withdrawn in stages and taxed at the beneficiaries’ marginal income tax rates, rather than being subject to an immediate 55 per cent tax charge.

As chancellor George Osborne announced during last year’s Budget, people no longer have to annuitise, with new routes to taking retirement income being introduced.

First of all, individuals can take money direct from their pension pot with 25 per cent of this being tax free.

This is called an uncrystallised funds pension lump sum (UFPLS) and can be taken in one or more payments, regularly or irregularly.

The other new option is flexi-access drawdown, which lifts the limit on how much or how little can be taken from a drawdown fund each year.

Fiona Tait, pensions specialist at Royal London, explains that if someone withdraws the lot all in one year, it is going to be taxed in that year and only subject to that year’s allowances.

So Ms Tait says the lump sum withdrawal route is likely to be the most costly from an income tax perspective.

“Annuities, at the other end, effectively allow people to spread their income over the rest of their life, meaning you get allowances each year.

“Then in the middle is flexi-access drawdown, where the individual has a choice to say exactly how much they are going to take out in each tax year, making the most of the allowances proactively.”

Prudential’s retirement technical manager Les Cameron points out when it comes to selecting a retirement income option it all depends on the tax people are looking to tackle – be that inheritance, income, lifetime or annual allowance.

Mr Cameron notes that retirement planning is now all about holistically using the different wrappers available to minimise the impact, “blending all the stuff you’ve got to make the money last as long as possible”.

The changes to death benefits also mean that using the pension pot as a last resort for retirement income increases the chances of passing on more inheritance tax free cash to dependents.

Mr Cameron explains that people should think about their spouses as well when it comes to thinking about their retirement income.

He says: “You can transfer them the income-producing assets like a buy-to-let portfolio, while you keep the pension in your name. This all plays into your personal allowance usage – splitting things across a couple can be very beneficial.”

On the tax treatments of the various options upon death, Royal London’s Ms Tait notes that those who opt for full lump sum withdrawal leave that all exposed to inheritance tax on their estate.

“If they go for the annuity, then when they die they could have some death benefits payable, which wouldn’t be subject to inheritance tax, however, there would only be a death benefit payable if the individual had actually chosen to structure their annuity that way,” she says, adding that this decision has to be made up front and money cannot be passed on any further than the direct dependent.

“Whereas, if they leave it in the pension using flexi-access drawdown, anything that is still in there can be passed on.

“It is not part of the estate and the beneficiary can also pass on anything that is left; cascading down the generations,” Ms Tait continues, warning that advisers and clients must check their pension scheme actually allows flexi-access.

Ralph Pettengell, deputy president of the Association of Taxation Technicians, agrees it is vital advisers check the options offered by their client’s pensions noting many older schemes may not have adapted to the new rules but there has been a “huge appetite” for taking benefits this way.

He says: “Understanding HMRC’s definition of dependents is also really important, because unlike death in service, the administrator can only appoint the dependent. To do this cascading down you’ve got to make that nomination yourself, otherwise the administrator is stuck.”