In Part 1 of my blog on taking Tax-Free Cash from your pension, we explored what Tax-Free Cash is and how it works. We also considered why ‘phasing’ your tax-free cash may be beneficial for some people. Following on from Part 1, in this blog we’ll continue to explore some important considerations with Tax-Free Cash.
I’m going to cover 7 key points that you may wish to consider when thinking about taking Tax-Free Cash from your pension. It’s worth noting that some of these are a bit technical, and it’s always best to form a plan with your Financial Planner that encompasses all of your personal circumstances and needs, rather than looking at any particular issue in isolation.
1) Flexi-Access Drawdown
Flexi-Access Drawdown is a type of pension that fully utilises the new Pension Freedoms and recent changes to pension legislation. It provides the flexibility to take regular withdrawals, lump-sum withdrawals, or even fully encash your pension. In addition, you can choose how and when to take your Tax-Free Cash. Flexi-Access Drawdown can also facilitate Phased Tax-Free Cash.
2) Protected Tax-Free Cash
Some older-style pensions offer what is known as Protected Tax-Free Cash. This means that the pension provider guarantees a pre-determined level of Tax-Free Cash, which is typically in excess of the usual 25%. This can be a significant benefit, depending on the amount of Protected Tax-Free Cash and the pension value.
In some cases, it may be worth retaining an older pension, rather than transferring it into a new pension, in order to retain the Protected Tax-Free Cash. For this reason, among many, it is always advisable to fully assess the pros and cons before transferring a pension from one provider to another.
3) Lifetime Allowance (LTA)
The Lifetime Allowance is a limit on the total amount of pension benefit that can be drawn across all your pension schemes and be paid without triggering an extra tax charge. The Lifetime Allowance has reduced over the years, but since 6th April 2016, its current level is £1m. Every time you take any Tax-Free Cash from your pension, you crystallise some funds, which gets tested against your Lifetime Allowance.
Tax-Free Cash is normally limited to 25% of the Lifetime Allowance, but you may be able to receive more than this if you have applied to HMRC in the past for either Scheme-Specific Lump Sum Protection or one of Enhanced Protection, Fixed Protection or Primary Protection. Again, this can be a significant benefit, depending on the level of protection and your combined pension values.
We have helped many clients apply for these types of protection over the years, which is one reason why it can be extremely valuable to have an ongoing relationship with an Independent Financial Adviser.
4) Death Benefits
If someone died with an Uncrystallised pension, this would be tested against the individual’s Lifetime Allowance (LTA) and, if benefits go above the Lifetime Allowance, any extra tax charge would be payable. Crystallised pensions would have already been tested against the LTA, so these would not need to be tested again.
Once the above has completed, depending on the age, if someone died with a Money Purchase (Defined Contribution) pension, their beneficiaries would have option of taking the following benefits:
|Option||Before Age 75||Age 75 or over|
|1||Lump Sum payment||Tax-Free||Taxable at the Beneficiary’s marginal rate|
|2||Income (via Drawdown)|
|3||Income (via Beneficiary’s Annuity)|
As you can see, sometimes the tax-status of a potential beneficiary may affect the nominations made.
5) Wills and Expression of Wish
With all things financial, it is worth ensuring that your Wills are up to date and that you have completed an Expression of Wish form for all of your pensions. This helps to ensure that your wishes would be adhered to in an expedient fashion.
6) Your Estate and Inheritance Tax
It’s worth noting here that pensions sit outside your Estate for Inheritance Tax purposes so, in some circumstances, it may be advisable to drawdown on investments that form part of your Taxable Estate prior to drawing down on your pensions.
7) Recycling Tax-Free Cash
This is where someone enhances their pension by re-investing their Tax-Free Cash into a pension to gain more Tax-Relief. This is only allowable if the amount of Tax-Free Cash received over 12 months is less than £7,500 and so long as the individual has other Relevant Earnings in the UK.
In summary, there are many important considerations with Tax-Free Cash and the following options should be explored fully before making any decisions:
- Whether to take some, all or even none of your Tax-Free Cash
- Whether to phase your Tax-Free Cash to supplement your Taxable Income
- Protected Tax-Free Cash (if any)
- Lifetime Allowance (LTA) and LTA Protection (if any)
- Your age and Death Benefits
- Your Beneficiaries’ Tax-Status
- Your Wills and Expression of Wish
- Your Estate and Inheritance Tax
- Recycling Tax-Free Cash
As mentioned in Part 1, all of this depends on your personal circumstances and needs, both now and in the future. There’s no ‘one-size-fits-all’ solution, so you should always seek Independent Financial Advice when considering your retirement income options.
Please remember that the value of investments and income from them may go down as well as up and you may not get back the amount originally invested. Information is based on our current understanding of taxation legislation and regulations. Any levels, bases of and reliefs from taxation are subject to change.