Tax-efficient Pension Planning


Jan 22, 2016


Pensions Personal Finance Tax

By Patrick Cooper, Director at Paish Tooth Ltd.

Over the last two years many changes have been made to pensions, and the Government hasn’t finished yet. We’re all living longer nowadays, and we need more money in our old age. Set this against a background of lower investment returns, and you begin to see why the Government is keen to encourage us to save more. Pensions freedom was first announced in 2014 to sit alongside workplace pensions and auto enrolment, as well as changes to the basic state pension. Further changes announced in 2015 will limit tax relief for high earners, increasing the amount of tax collected by the Government. We are promised further changes still, maybe even a radical reworking by abolishing tax relief on contributions altogether, and not taxing the pension when it is drawn. This would make pensions very similar to ISAs. These further pension announcements may come even as soon as the March Budget.

In the past, those who retired gave their accumulated pension savings to an insurance company in exchange for an annuity, a guaranteed income for life. However the annuity rates offered have been seen as disappointing, and people have been deferring this decision in the hope that rates might improve. Up until 2011, everyone was forced to buy an annuity once they reached age 75.

‘Pensions Freedom’ in a nutshell
As well as giving pension funds a valuable boost in the form of tax relief on pension contributions, the Government has now decided that in order to further encourage pension savings, we can all be trusted to manage our pension funds responsibly and choose how much and when we take money from them.

This is achieved by drawing an income from your pension funds, whilst leaving the bulk of your funds invested to hopefully benefit from continued long term growth. Anyone aged over 55 can start accessing their pension funds even if they are not retiring. Advice will be especially important if you still want to make substantial pension contributions, or if you don’t want to fall foul of the rules or trigger unexpected tax charges.

It is still possible to take a pension commencement lump sum of up to 25% of the fund, free of tax. Further payments can then be deferred, set as either regular amounts or if the funds are small enough, taken as a single lump sum. These will all be subject to tax in the year that they are drawn, so must be considered alongside all other income for the tax year.

What other good news is there?
Death before aged 75 has always been tax efficient, as generally all payments to beneficiaries are free of tax, whether they take a lump sum or continue with a regular drawdown plan. There is no charge to Inheritance Tax as the value of the pension funds are treated as being outside your estate.

If you are over 75 and die whilst drawing down money from your pension fund, your beneficiary can still receive a lump sum or income. During 2015/16 lump sums are taxed at 45%. From 6 April 2016, this will be taxed at the beneficiary’s marginal rate of income tax.

Previously only dependants could benefit from funds in your pension. However, it is now also possible to nominate successors and pass your pension funds on to anyone, including future generations. There is no requirement for them to wait until they reach age 55 to access the funds.

For those who have other sources of income to support their retirement, there is now the real prospect of having funds left in your pension when you die. These funds remain invested in a tax free environment and outside the beneficiary’s estate for Inheritance Tax.

So what are my options?
So much has changed lately that everyone should reassess their pension fund position.

For those who are still saving for their future retirement, it is vital to ensure you are getting the maximum tax relief to boost your investments. You should ensure your funds are well managed and seek the help of an independent financial advisor.

For those who are planning to start accessing their pension funds in the near future we can help you plan to minimise your tax liabilities.

If you are now drawing down on your pension and have funds available, you might now wish to consider whether it is better to leave your pension wealth to future generations, as a part of your overall Inheritance Tax planning.

Everyone must also ensure their will is up to date and as tax efficient as possible. If you do not have a will, we can help organise your plans before you instruct a solicitor to draft the paperwork.