Is your pension tax efficient?
Since April 2015, pensioners have had greater freedom over how they manage their retirement savings. No longer forced to buy an annuity, they can now leave their money invested and draw an income from it (known as flexi-access drawdown).
Whether you’ve already stopped working, or you’re planning to retire soon, you should be familiar with the various allowances and tax-efficient accounts which may reduce your tax liability. Here’s a brief summary:
Tax-free lump sum
You can take a tax-free lump sum of 25% of your total pension pot. With the rest, you can either buy an annuity or reinvest it and draw an income. Alternatively, you can withdraw the full pot as cash and pay tax on the other 75%, or delay taking it so it remains invested.
Another option is to take smaller amounts on a more regular basis and leave the rest untouched. Each time the first 25% is tax-free, but you pay tax on the balance. In this case, your pot isn’t reinvested.
For anyone earning up to £100,000, you don’t pay tax on any form of income up to the personal allowance of £11,500 (in the 2017-18 tax year). This allowance is reduced by £1 for every £2 earned above the threshold. So when you stop working and start drawing pension income, you won’t pay tax on it until the payments exceed your personal allowance. However, as long as you’re still employed, even in a part- time job, your earnings eat into your allowance. The tax-free lump sums discussed earlier don’t count towards your personal allowance.
Individual Savings Accounts (ISA)
If you decide to withdraw a lump sum, one option is to put it in a cash or stocks and shares ISA. ISAs are tax-efficient accounts which protect returns (interest earned in a cash ISA, and gains and income generated by a stocks and shares ISA) from income tax and capital gains tax. The annual ISA allowance of £20,000 in the 2017-18 tax year may come in handy if your pot is big enough.
You can earn dividends tax-free on investments you hold outside your ISA thanks to the annual dividend allowance. This is £5,000 for the 2017-18 tax year, although it falls to £2,000 from April 2018.
Personal Savings Allowance (PSA)
You can also take advantage of the PSA for any savings you have outside a cash ISA. Basic rate taxpayers can earn £1,000 in interest tax-free and higher rate taxpayers can earn £500. Additional rate taxpayers don’t get a PSA.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
The value of your investments and any income from them may fall as well as rise and is not guaranteed. You may get back less than you invest. Stocks and shares ISAs are considered medium to long-term investments and you should be prepared to invest for at least five years.
If you’d like advice on your retirement options or pension income, please get in touch.
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