Pensions reform extends flexibility for retirement savers.
Michael Garvey explains the Government’s latest pension carrot and what the stick is this time.
Sweeping changes to pension legislation have transformed the flexibility available to pension policy-holders and their rights to access benefits from age 55. This throws the door open for the reckless to completely decant their retirement fund into cash if minded to do so; where previously bound by government-set limits for income.
Pension providers have panicked, Osborne and Cameron are counting the votes they believe the move has bought, HMRC is playing catch-up and the media have been fairly lax at communicating the real drawback as usual – tax. As before, generally up to 25% of pension funds may be taken as a tax-free cash lump sum, with some notable exceptions offering a higher proportion. Now election for the remaining fund to be taken as income under flexi-access drawdown is limited only by the extent of the fund, the beneficial owner’s motivation to pay income tax at up to 45% and also potentially lose their personal allowance (the first £10,600 of income on which no tax is paid, 2015/16).
The operation of UK income tax relief on pension contributions dictates that HMRC expects to claw-back at retirement at least some of the incentive given to pension savers while accumulating their pension fund. However, those who intend to use their retirement fund to top-up their income – particularly those who continue to work – may be in for a shock when learning how that tax mechanism works in practice. The difficulty is that not all pension providers will have an accurate handle on the recipients tax code; resulting in an emergency code (think 45% by default) being applied to the income tranche taken as if the payment taken were to be on a continuous monthly basis until the end of the tax year. Furthermore, this tax will be taken by the pension provider and remitted directly to the Treasury. Of course, any tax overpaid can be claimed back in due course but not until the end of the tax year when the calculation can be carried out and with the additional hassle of submitting a tax return (for those who don’t already).
The new pension freedoms are of course great news for prudent pension investors (and their advisers) who are at or approaching retirement and who can use the new-found flexibilities to carve out tax-efficient cashflow in retirement with careful management. From experience, what retirees intend to spend retirement income on early in retirement is very different from what that looks like in our winter years and so the ability to extract a higher level of income early on in retirement is usually welcome.That being the case, care has to be exercised to make sure that both can be afforded i.e. money does not run out into our eighties (or beyond) and that any tax-take erodes income by a minimum.
Tax relief on pension contributions coupled with funds growing free of income tax and capital gains tax make compelling incentives to save for retirement using pension structures. However, when the time comes to take benefits, the taxman cometh… and the right advice will be crucial.