Category : Tax-free cash

Tax-free cash in the 2016 Budget

Posted By: Phil Handley DipPFS AwPETR On February 29, 2016 Category: Tax-free cash

I’ve had an influx of people last week enquiring about taking 25% tax-free cash from their pension before the Budget (2016). Steve Webb, the former Liberal Democrat Pensions Minister, writing for the Sunday Times, suggested that George Osborne could be set to axe access to the pension tax free lump sum.

The 25% tax-free cash element of pensions is one of the biggest incentives to pay into one. Many people look forward to taking this tax-free cash at retirement and rewarding themselves with a holiday or a new car.  Other rely on it to pay off their mortgage.

And herein lies the problem with the proposed claims.

Abolishing the right to this money would leave thousands of people in mortgage difficulties, even homeless. For those who have taken interest only mortgages, or even pension mortgage where the pension was geared up to pay off the mortgage, there is going to be a final demand from the bank with no ability to repay.

Yes, the pension freedoms do now allow full access to your savings, however with a tax burden as it’s treated as earned income.

It would be political suicide for Osborne to make such an announcement, and it’s a decision which would affect everyone.

Of course there is no guarantee that it couldn’t happen, it’s just highly unlikely.

If there was going to be any raid on tax free cash it’s more likely to be for future contributions, and therefore locking in any previous entitlement. The incentive to do this is it could save the Treasury £4 billion a year.

There are of course, further changes expect to pensions in the Budget 2016. We’ve had to virtually retrain in the industry as professionals over the last few years. On this year’s likely agenda is a change to the tax on contributions.

Some commentators are forecasting an equalisation of tax relief. So rather than a higher rate tax payer receiving 40% and a basic rate tax payer 20%, maybe a flat 25% for all.

Others are talking up an ISA-style saving vehicle, where contributions are paid from taxed income, with no income tax to pay once in retirement.

The ISA style savings vehicle is more likely what Steve Webb was referring to meaning a future loss of tax free cash, not benefits already accrued. The media reaction to the comments have left people feeling a little uneasy, with one of my clients saying it’s not the right time in his life to be taking risks on what might happen, and insisting he wanted the tax-free cash now whilst the rules still exist.

Alternative tax-free cash options for your pension

Posted By: Phil Handley DipPFS AwPETR On February 11, 2016 Category: Drawdown tips Tax-free cash

If you’re looking to retire in the next few months and had your sights set on drawdown, you might be panicking with current market conditions. Your fund will have inevitably gone down and depending on how you were invested, this may be significant.

If you need to take an income from your pension to replace your salary, you’re going to have to make a choice where to put your money.

Whether this be an annuity or income drawdown, the tax-free cash figure you calculated a few months ago is likely to be less when you make your choice.

Being forced to take less tax-free cash just because you need an income is a bitter pill to swallow. Worry not, there are alternative ways to have access to your pension without locking in the lower tax-free cash.

I have recently suggested some alternative strategies to some of my clients which provides a chance for their tax-free cash to increase again.

The current school of thought by many is that when you want an income from drawdown, you crystallise (move your pension from the accumulation stage to the decumulation stage) all your pension in one go. It’s well know that at this point you can take 25% of your fund tax-free and the rest goes into a drawdown plan, which you can later draw an income from.

The downside to this is that you can only take your 25% once, and at the market value of your fund when you move it.

A little-known form of drawdown which was used before the pension reforms was called phased drawdown. Rather than move all your fund at once, you would take chunks as you need them.

How does this help?

Take this example.

Mr Smith and Mr Jones want to retire at 60 and have the same pension fund with the same value. They need £10k per year income after they retire.

Mr Smith has a fund of £125,000 6 months from retirement. On his retirement date, his fund is now only worth £100,000.

Mr Smith crystallises his £100,000 pension fund. He’s allowed 25% (£25,000) tax-free. £75,000 is then moved into drawdown which he can take further (taxable) income from.

Over the next 6 years until his state pension age he uses his £25,000 tax-free cash and a further £35,000 from his drawdown fund. As his income requirement is below the nil rate band for paying income tax (currently £10,600) he pays no tax during this time.

During this 6 year period his fund grows 4% per annum.

When his state pension starts, this uses up all his nil rate band meaning any further withdrawals from the crystallised drawdown will be subject to income tax.

He has no further tax-free cash to take and all his drawdown income is now taxable.

Full tfc drawdown

Mr Jones is in the same fund and retiring at the same time. He decides to use a phasing technique however.

Rather than take all his tax-free cash at the outset, he crystallises £10,000 (his income needs) per year.

£2500 of this is automatically tax-free however and the remaining £7500 is below his nil rate band, he also pays no further tax on his income.

At 66 his state pension starts and uses all his nil rate band meaning any further pension income will be taxable.

His fund has also grown by 4% per annum during this period.

Phasing drawdown

The difference with this method is that Mr Jones has further tax-free cash to take as he didn’t crystallise all his pension on day one.

In the above example Mr Smith has had £25,000 tax-free cash entitlement and Mr Jones will have £43,834 (6 x £2,500 plus the allowable £13,834 at the end) tax-free cash entitlement. They have both achieve the same income.

This above example might be presuming an ideal scenario but the concept is evident. Markets could equally decline leaving access to less tax free cash, however at least you are giving them time to recover.

There are two ways which this can be organised. Either finding a provider who offer a pension & drawdown in the same plan. This will allow easy movements from the uncrystallised to the crystallised part whenever income is needed.

The second method is by find a provider who offers Uncrystallised funds Pension Lump Sums (UFPLS).

It’s important to realise that there are alternative options in these depressed markets. Just make sure you’ve done your research before crystallising your fund as it can’t be reversed once the decision is made.

Summary of your retirement options

Posted By: Phil Handley DipPFS AwPETR On March 14, 2015 Category: annuities Pension drawdown Tax-free cash UFPLS

Making the right choice with your pension fund has become even more difficult with the introduction of the new reforms. We have summarised the key advantages and disadvantages of the main options. It’s also important to note that you don’t have to make a commitment to one option; you can mix and match to suit your needs. As an example, it might be prudent to take out an annuity to cover your fixed monthly outgoings and use flexi-access drawdown to provide some flexibility.

 AdvantagesDisadvantages
Full cash withdrawal• Access to full pension fund
• 25% tax free
• No restrictions on what you spend it on
• Could be used to reduce liabilities
• 75% taxed against earned income
• Could move you into a higher tax band of 40% or 45%
• Not a lifetime income if all spent quickly
Flexi-access drawdown• Flexibility to take income as required
• Allow you to take income within tax threshold
• Ability to change income to an annuity at a later point
• 25% tax free
• Keeps fund invested give potential growth
• Tax efficient growth on invested fund
• Assets can be passed onto estate
• Investment risk and potential for fund to lose value
• 75% is taxed against earned income on withdrawal
• Could run out if large income taken and you live into later retirement
• Ongoing cost to run with management and platform fee’s
Fixed Term Annuity• Fixed income for a fixed term
• Guaranteed maturity value
• Ability to purchase an annuity in the future
• No investment risk
• Assets can be passed onto estate
• 25% tax free
• Future risk if the guaranteed maturity value may by a lower income than today if annuity rates are worse
• Can’t change the level of income during the fixed term
UFPLS• Flexibility to take ‘chucks’ of income when needed
• 25% with be tax free, 75% will be taxable against income
• Allows continued investment of unwithdrawn funds
• Untaken funds grow tax efficiently
• Investment risk of remaining funds
• 75% of any withdrawn funds taxable
• Low take up from providers offering the facility
• Income/capital is not guaranteed for life
Annuity• Guaranteed lifetime income
• 25% tax free
• Inflation proofing can be built in
• Any untaken funds can be passed onto estate on death (value protection). Only available through certain providers
• Control over assets given up
• No flexibility once taken
• Historic low rates meaning you’d have to live many years to get value back