Q & A: Do you know the tax implications of taking your pension?

Do you know the tax implications of taking your pension? Do you know what kind of income is right for your retirement? Do you know what happens to your pension when you die?

Our new client Peter didn't until we reviewed his retirement plans! 

Peter is 50 years of age, married & currently has 400,000 in a personal pension.  Here is how we helped him understand his concerns!

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1. Do you know the tax implications of taking your pensions?

'I am still not fully certain of the whole range of tax implications associated with taking pensions, even with all my pensions now incorporated into one of your platforms?'- Peter
 
Below we have three examples of how retirement planning can minimise the tax implications when Peter starts to take income in retirement.

Example 1 shown in the table below, Peter has taken the 25% tax free lump sum (£100,000) and with no thought to retirement planning, he has spent it. He's decided he will need £20,000 income per year in retirement.
Peter can use his £11,750 personal allowance to withdraw tax free income, however the rest of his income will be taxed at 20%.

Example 2 shows Peter has thought about his retirement plan, and considered how he will spend his tax-free cash. We would advise Peter to consider his income planned is from taxable and tax-free sources. This way Peter will be able to crystallise less, take out more money, and pay less tax.

Finally;

Example 3, shows how this model can work when a higher income rate is needed per year (e.g £30,000). 

Example 1-
Standard model of income throughout retirement 

Example 2-
Phased Drawdown
 33K Crystallisation 

Example 3-
Phased Drawdown
 73K Crystallisation 

Example Income

£20,000

£20,000

£30,000

Initial tax-free cash lump sum

£100,000 (and spent it)

£8,250

£18,250

Remaining Pension fund (Taxable)

£300,000

£24,750 in drawdown

£54,750 in drawdown

Tax free portion

£11,750 (tax year 2018/19)

£11,750 (tax year 2018/19)

£11,750 (tax year 2018/19)

Taxable portion

£8,250

£0

£0

Income taken from the tax-free cash

£0

£8,250

£18,250

Net income 

£18,350

£20,000

£30,000

Tax Paid

£1,650 (20%)

£0

£0

What does this mean?

Phased Drawdown usually works well for clients such as Peter who have large pension funds, or have other assets available for income. This is because the bulk of your pension savings remain invested. If Peter decides to use this model in his retirement plan, we would advise Peter considers converting smaller portions of the fund regularly (usually once a year), using the existing pot to take cash as and when he needs it, leaving the rest to continue to grow tax free. 

The key point for making this model work effectively is to always use your personal income allowance (£11,300 in this tax year £11,750 next) from the drawdown/taxable pot and use the tax free cash element to fulfil your needs over and above this. 

This model maximises pension funds for as long as possible, you will end up drawing out more income, for longer with less tax payable, displayed example 2 & 3 in the table. 

2.Do you know what kind of income is right for your retirement?

'What income do I need when I retire?'-Peter

The key to knowing how much you need when you retire, is planning.
The closer you are to retirement the easier this may be for you.
From our experience, we have a lot of clients who spend more money in the earlier years of retiring. (E.G holidays, cars, campervans)

Everyone's circumstances are different, things you should think about:


  • check
    How much your likely retirement income
  • check
    How much will you receive from state pension, and how much extra money will you need after state pension as an individual? (We have found, in most cases, £1000pm will cover most people in the UK in their 70's)
  • check
    Have you paid off your mortgage?
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    Consider ways to boost your pension, such as savings
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    Think about when you would like to start taking your pension
  • check
    Consider your family's situation

Review your plan at least once a year, you are planning for a better future. 

3. Do you know what happens to your pension when you die?

'My assumption is when I die, my wife will receive a lump sum of the value of my pension plus my children will receive as defined beneficiaries'- Peter

On death, phased drawdown provides a flexible income for your surviving dependants, or a lump sum (depending on the terms of the pension).
If Peter dies below the age of 75, the crystallised funds can be paid to any beneficiary completely tax free- as a lump sum, annuity or pension drawdown. The benefits will be tested against the lifetime allowance.
The funds crystallised in drawdown can also be passed on tax-free to any beneficiary as lump sum or as drawdown pension.

If Peter dies over the age of 75, the uncrystallised funds can be paid to any beneficiary tax at their marginal rate.

Peter and his family will be given advice to consider a strategy in place for what happens to the remaining pension pot, if his beneficiary continues to have the money in a pension scheme, or extract the money. 

If you have any questions regarding your pension or retirement options, get in contact with one of our advisers today!

It is important that no actions should be taken without advice, and the risk warning should be taken notice in all cases. Personal circumstances and risk profile mean that the advice for one person which may not be the same for everyone. This article is based on tax implications for 2017/2018.

Nigel Reeves

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About the Author

By Nigel Reeves: My mission is to provide the quality, honest & jargon-free pension advice that people need to secure the retirement they deserve. At home, I'm a family man and an active supporter of grassroots sports!

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