Back in 2015, the government introduced the pension freedoms act. Research by Old Mutual has shown that in the first two months, a staggering £72.8m in tax was generated due to these freedoms. This is equivalent to an annual tax boost of nearly half a billion pounds, significantly higher than expected.
It was originally feared that the freedoms would lead to pensioners withdrawing vast sums of money, drastically diminishing their income security in retirement. However, with an average withdrawal of £16,000, it is obvious that the vast sums of tax came about through poor planning.
Here are a few things to consider when deciding how to access your pension:
25% of your pension pot is tax free, and the remaining 75% is taxed as income. This tax-free amount can either be taken all in one go, or by taking smaller cash sums of which 25% of each chunk is tax free.
If you were to go down the lump sum route, it is worth noting that it is not possible to leave the remaining 75% untouched. You must either:
- Take the whole pot as cash
- Buy an annuity (guaranteed income)
- Get an adjustable income (flexi-access drawdown)
Aside from your personal pension, you will also be paying income tax on earnings from employment or self-employment, your State Pension, and any other income that you may have.
If you continue to work whilst drawing down your pension, your employer will take any tax you owe off your earnings and your State Pension. While retired, the provider handles this.
You must also consider the lifetime allowance. This is currently set at £1 million, over which you will be taxed heavily. In a defined contribution scheme, this is simply determined by the amount of money in the pot that goes towards paying you. However, with a defined benefit scheme, it is usually 20 times the pension you get in the first year plus your initial lump sum.
The tax rates above your lifetime allowance are 55% if you take it as a lump sum, or 25% if you take it any other way.
As always, we urge pensioners to seek the expert advice of offshore specialist financial planners to ensure that they make tax efficient and flexible use of their hard-earned pension pot.