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Tax-Free Cash (Pension Commencement Lump Sum)
Most pensions will allow 25% of the fund value to be taken as tax free cash (Pension Commencement Lump Sum) from the age of 55.
Tax free cash can be very useful to repay expensive debts but what if you don't actually need the lump sum?
Moving money from a tax efficient pension environment to a taxable and low interest generating environment makes little sense. It should be remembered that tax free cash can be accessed at any time.
A highly attractive and tax efficient alternative to taking tax free cash is to adopt a 'phased' retirement strategy. Phased retirement strategies can apply to annuities or drawdown solutions and essentially involve combining some tax free cash with annuity/drawdown income to meet overall annual income requirements.
Pension Death Benefits
Death before age 75:
Any lump sum or income payment from the pension, whether from drawdown, annuity or from unvested plans, will be completely free of tax. There is no restriction on who you can nominate as a beneficiary.
Death after age 75:
Any lump sum payment from the pension (whether drawdown, annuity or unvested plans) will be subject to a 45% tax charge in the current tax year and thereafter would be taxed at the beneficiary’s marginal rate.
Where the fund is used to provide income to a beneficiary then this income will be taxed at their own marginal rate. Payments could be made to several beneficiaries, perhaps using their personal allowance or 20% tax band.
If a beneficiary subsequently dies the tax status of any remaining payments will depend on whether they were under or over age 75 at death: if a beneficiary who is receiving taxable income dies under age 75 the remaining fund would become tax-free to their successors.
A beneficiary can nominate anyone as their successor.
Usually, pension funds are free of any Inheritance Tax (IHT).
UFPLS (Uncrystallised Funds Pension Lump Sums)
UFPLS is a way of taking some or all the money from your pension which has not yet been crystallised (i.e. is not yet in drawdown, been spent or used to buy an annuity).
25% of each UFPLS payment will be tax free and the remaining 75% will be subject to income tax at your marginal rate (although initially this could be taxed more heavily under an ‘emergency code’ under PAYE in which case you need to reclaim any excess from the tax office)
Care needs to be taken in terms of tax planning and sustainability of income. Large withdrawals could mean paying unnecessary tax and will naturally reduce the amount available to provide an income in the future.
Who should consider UFPLS?
With other flexible retirement income options available, it’s likely UFPLS will only be suitable for a few people, for example if it’s a small pension pot and you need the money to clear off or reduce expensive borrowings. However, those who want to take some cash from their workplace pension scheme whilst remaining a member, may want to consider it if the scheme offers this as an option.
We recommend you seek advice before considering UFPLS.
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State Pension & Age
The government is taking steps to simplify the UK state pension and to change the state retirement age. Life expectancy in the UK has continued to increase and it is perhaps not surprising that the state pension age needed to increase to reflect our increased longevity and to promote sustainability of the state pension.
- Changes to state pension:
The government introduced the new flat rate (single-tier) pension in April 2016. The amount of pension is approximately (2020) £175.20 a week (£9,110.40 per year) and will rise annually under the current 'triple lock' government promise.
People who reached State Pension age before the introduction of the single-tier pension continued to receive their State Pension in line with the previous rules.
- Changes to state pension age:
The government has proposed that:
- people born between 6 April 1960 and 5 March 1961 will reach State Pension age between 66 and 67
- people born on or after 6 March 1961 will reach State Pension age when they’re 67 or older
This change hasn’t been approved by Parliament yet.
Under the current law State Pension age will already increase to:
- 67 between 2034 and 2036
- 68 between 2044 and 2046
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Annual and Lifetime Pension Allowances
The annual allowance is the amount of money you can invest in a pension and attract tax relief. From 6 April 2014, the annual allowance is £40,000* but it may be possible to make a larger contribution as you can carry forward 3 years of unused relief.
However, if you trigger one of the events listed below, you will only be entitled to the ‘money purchase annual allowance’ which has been set at £4,000, as the amount you can pay into a money purchase pension and still receive tax relief.
- An income payment from flexi-access drawdown
- A payment of an UFPLS
- Payment under a flexible annuity contract
- Payment from a scheme pension
Please note, it is possible to take your tax free cash entitlement only from a flexi-access drawdown plan and still retain the full £40,000 annual allowance, as long as you don’t draw an income. You can also take your annuity income (from most annuities) and retain the £40,000 annual allowance.
* Tapered annual allowance: From April 6 2020, individuals with total taxable income plus employer pension contributions above £240,000 (previously £150,000) during the tax year will face a reduction in their annual allowance by £1 for every £2 in excess of £240,000. The minimum tapered annual allowance has reduced to £4,000 (previously £10,000) and this reduction will affect those with taxable income plus pension contributions above £300,000; with those at £312,000 and over receiving the new £4,000 minimum tapered annual allowance.
The lifetime allowance is the maximum amount that can be held in your pensions without potentially incurring a tax charge on the surplus.
The lifetime allowance for 2020/21 is £1,073,100.
To read our quick guide to the lifetime allowance and current protections available, please click here.
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Risks in retirement
The 6 key areas of risk that you will face in retirement are as follows:
- Longevity Risk: The risk that you live too long.
- Inflation Risk: Because we are all living longer, the corrosive effects of inflation can have a significant impact on retirement income and your standard of living.
- Investment Risk: To mitigate the effects of inflation, you need to generate real investment returns, usually associated with equity investments.
- Sequencing Risk: Sequencing is the order and timing of investment returns and the risk in pension drawdown is that negative returns (especially in the early years) can have a devastating impact on the value of the drawdown fund. This is because investment losses created by selling assets to meet cash/income requirements can never be recovered.
- Withdrawal Risk: Simply the risk that you draw benefits too quickly and run out of retirement funds to maintain your desired retirement income, and finally;
- Liquidity/Flexibility Risk: The risk that you don’t have sufficient resources and/or flexibility to meet your changing financial requirements throughout your retirement
In addition to these key areas of risk to be mitigated and managed is the desire for many individuals to bequest part of their pension to their next of kin, particularly in the event of a premature death. Having worked hard over many years to build up retirement funds, it is not surprising that people want to see that value retained in their estate.
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Post Retirement Planning
Retirement is no longer a one-off process, particularly if using flexi-access drawdown, and should be an ongoing journey to take account of changes in circumstance, objectives and markets. Specialist advice and ongoing reviews will ensure that you are in a position to make the right decisions at the right time to maximise your retirement objectives.
Managing pension funds to achieve sustainable retirement income is our speciality and we invite you to contact us to see how our service could help you make the right retirement choices.
To read more about Post-Retirement planning, please click here.
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