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 6th 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.
