Pension Freedom

With the new pension freedom rules just weeks away, anyone considering drawing their entire fund or a large chunk of it should carefully consider the impact this may have on their estate and tax position.

Under the new rules, after April 6^th you will be able to draw as much of your pension fund as you like. It sounds great on the face of it, however you must be careful to plan ahead for the tax liabilities:

·         First of all, your payment will be taxed under an emergency tax code and on a ‘month one basis’.

o   This means that if for example you take £10,000 from your fund, even if you don’t intend to take more than that in the tax year, you’ll be taxed as though you are taking £10,000 per month and so £120,000 in the year. In this example you would immediately be taxed 40% (£4,000) and you would have to claim the tax back.

·         Any income you take should be added to any other earned income in the tax year you are taking it. If the figure being drawn takes your income above £42,386 (tax year 2015/16) then you will be liable for higher rate tax at 40% on any income above this figure.

o   This will need declaring on a self-assessment tax return – something you may not be aware of and the liability wont be due immediately

o   You don’t want to be in a situation where you have spent the money you drew down without realising there’s a potential tax charge to pay down the line

It is also really important to consider your long term retirement income and what your strategy for drawing it down will be. If you draw too much in the early days, you may find that your pension fund runs out before you expected. Consider how this would affect your desired standard of living.

A different point which hasn’t been mentioned much is the impact a large drawdown may have on your estate. Really important to consider what your estate is worth before and after any potential drawdown.

·         Will any potential drawdown make your estate worth more than £325,000? Any excess has inheritance tax applied at 40%.

o   £325,000 is the ‘nil rate band’ each individual has as standard.

o   Some may have enhanced nil rate bands if they have inherited some or all of their late spouse’s nil rate band.

o   The arrangements in your will may allow for a higher nil rate band on second death of a married couple.

o   Important to remember that money in a pension fund does not form part of your estate, so drawing down funds brings those funds into your estate

Lots of planning opportunities with this big change to legislation. Also lots of pitfalls which you need to be careful to avoid. Best to go into it with your eyes open and fully understand the impact any drawdown will have, not just on the obvious points.

This article is for information only and before undertaking any specific action please seek independent financial advice.