Pension Changes Scotland

This is a reminder that the deadline to make a pension contribution and claim tax relief this tax year is midnight on Sunday 5 April.

• Every UK resident under 75 can receive 20% tax relief automatically – for instance, you make a payment of £8,000, to which the government adds £2,000 to make a total contribution of £10,000.
• If you pay higher-rate tax (40%), you can currently claim back up to a further 20% through tax return so the effective cost of a £10,000 contribution could be as little as £6,000.
• If you pay top-rate tax (45%), you can currently claim back up to a further 25% through your tax return, so the effective cost of a £10,000 contribution could be as little as £5,500.

Tax rules can change and the amount of tax relief to which you are entitled depends on your personal circumstances.  To receive full tax relief you must have paid enough higher or top-rate tax.

What are the new freedoms and why are they making pensions more attractive?

• Unlimited withdrawals
  From age 55 (57 from 2028), an investor will be able to withdraw what they like without restriction.  25% will usually be tax free and the rest taxed as income.  Most people have faced limits on how much they can withdraw each year, so investors will have much more freedom.
• More ways to take the tax-free amount
  Investors will have more choice over how they take the tax-free part of their pension when they retire.  They can take it all in one go, or spread it out so a portion of any withdrawals are paid tax free.
• Pension death tax scrapped
  The 55% pension ‘death tax’ will be abolished.  Money left in a private pension (such as SIPP) can usually be passed to your heirs with no inheritance or death tax.  Any withdrawals they make will also be tax free if you die before 75, or taxed as income (45% if taken as lump sum) if you die aged 75 or over.  This is significant improvement as 55% tax currently applies to any lump sum payments from your fund if you die after turning 75 or are in income drawdown.

Even if you don’t qualify for flexible drawdown, there may be some reasons not to delay taking pension benefits even if you want to take your entire pension fund without buying an annuity. So from April 2015  if you have a pension fund of £50,000 you can take £12,500 as a tax-free lump sum, and the remaining £37,500 as a taxable payment.

Suppose you have earned income of £20,000 already, then this would put around £20,000 of the pension into the 20% tax bracket, which would mean £4,000 of tax, and the remaining £17,000 into the 40% bracket, meaning tax on this element of  (losing £6,800 of the £17,000 in tax). In this example, you would lose £10,800 in tax on the £37,000 that would be taxable.   
 
You could however start to take benefits now, and aim to stagger them. You could enter into an income drawdown contract now. This would allow you to take 25% as a tax-free lump sum. You could also then take no income.

Tax planning under the new rules

The new rules will allow people to take their pension all in one go, which can be expensive in terms of tax.
It may make sense to stagger taking benefits.

E.g Mr Smith has a pension of £80,000. He is aged 60.  He takes £20,000 as a tax-free lump sum, and then the remaining £60,000 as a one off payment. He earns around £10,000 per year (enough to use all of his personal allowance).
 
He receives (approximate figures)
£30,000 minus tax at 20%                    = £24,000
+
£30,000 minus tax at 40%                    = £18,000
 So of his £80,000 he ends up with £62,000, because all of the second £30,000 falls into the 40% tax bracket, so he loses £12,000 on this element.
 
Mr Brown’s circumstances are the same as Mr Smith’s, but he is a little more patient, and he takes his tax-free cash £20,000. He decides not to take any income. Two years later he stops work, and his income of £10,000 stops. He still has £60,000 in his pension, and he decides to take £15,000 for four years.

He receives (approximate figures)
£10,000 each year is tax-free                = £10,000
+
£5,000   minus tax at 20%                    = £4,000
 
He repeats this process for four years, and therefore gets £56,000.
In total he therefore gets                        £76,000

So you can begin to take benefits now, be it just a lump sum of 25%.