Don’t Fall Into The Pension Tax Trap

I have been having numerous conversations with clients’ in the weeks since the budget who are proposing to withdraw their entire pension fund as cash (as per the new budget announcements) and simply invest the proceeds in the bank or another form of taxable investment.

While I did write about this very topic a few weeks ago, I thought it sensible to mention it again so that people are aware of the consequences of such actions. As such I have prepared a simple worked example to compare the difference between withdrawing a 100k pension fund as one lump sum in cash and investing this in the bank and taking the income gradually from the pension over a number of years. This example is for illustrative purposes only and should not be construed as advice to act. If you are unsure about your own pension provision, you should seek advice from a chartered financial planner.

For the purpose of this exercise I am making a few assumptions:

– The client has £20k per annum in other retirement income from final salary and state pensions.

– The client would like to take a further 10k per year of income to make a total of £30k

 

Option 1 – Take the whole pension as cash on retirement

£25,000 will be paid tax free

£75,000 will be subject to income tax as follows

£21,865 @ 20% = £4373 tax

£53,135 @ 40% = £21,254 tax

The client would receive £74,373 in cash and pay £25,627 in tax

Any income that the money generated would possibly be subject to further income tax or capital gains tax.

 

Option 2 – Take the tax free lump sum and then £10k per annum as required

£25,000 will be paid tax free

£10,000 per annum will be taxed at £20% = £2000 tax

The total tax paid on the original £75,000 remaining fund will only be £15,000

The client would receive £85,000 – a difference of £10,627!

Of course the money would also continue to be invested in a tax efficient environment and could well make substantial further gains over the time period in question.

The above is clearly a very simple example, however it illustrates the taxation implications of taking large pension pots in one lump sum.

 

The point I am trying to make is that the full withdrawal of a pension fund will generally be very tax inefficient and should only really be considered if the fund is very small or there are specific spending plans for the money.

If you would like to find out more about the options available to you at retirement please get in touch to request your discovery meeting.

 

Budget 2014: Income Tax Changes

As expected, the chancellor has announced that the ‘personal allowance’ (the amount of tax free income an individual can earn before paying income tax) will increase to £10,500. This will remove further low earnings from income tax altogether.

In addition there will also be a small increase to the 40% tax band to £41,865. This will start to relieve the pressure on middle earners who have found themselves paying 40% tax for the first time over the past couple of years.

These changes were largely expected and have been rumoured for some time. The previous rules that reduced the personal allowance for those with incomes of £100,000 or more remains in place, and detailed planning will still be required for those with incomes of just over this amount.

Budget 2014: Your ISA is now NISA

The chancellor has just completed his budget speech and one of the key announcements was a reform to the ISA rules to make ISA savings simpler and more flexible. The government has decided to replace the ISA with the New ISA or NISA as it is referred to in the budget document. I wonder if this name will stick!

This change is positive in all senses and will surely encourage savings in the UK.

The changes in summary:

  • The ISA allowance will increase to £15,000 per annum from July this year.
  • The stocks and shares and cash limits will be merged into one.
  • Transfers will be permitted from stocks and shares ISA’s into cash ISA’s for the first time.
  • The junior ISA limit will increase to £4000 per annum.

All in all this simplification is great news for UK savers and investors and can do nothing to harm savings culture in the UK. When considered in tandem with the pension reforms announced today, it will be more important then ever to take a holistic view on retirement planning, as i alluded to in my blog a couple of months ago.

5 Days To Go!

In 5 days time George Osborne will deliver his 5th budget as chancellor of the exchequer. If the leaks and predictions are anything to go by (which they seem to be if the past two years are anything to go by) then this budget could have significant impacts from a financial planning perspective.

We are all too aware of the fragile state of the economic recovery and as such we expect this budget to be “cost neutral”. That is, any tax cuts or spending increases, will have to be paid for from increased takings elsewhere.

There is speculation that the chancellor may announce yet another increase to the state pension age (as I alluded to in my previous blog), as well as making yet further reductions to the annual or lifetime pensions allowances.

Add in the fact that there could well be a significant change to income tax legislation, and a reform of the capital gains tax rules, and we have a budget that anyone who is interested in financial planning will want to keep a close eye on.

We will be watching the budget and blogging live as it happens. We will also be preparing a short guide to the major announcements and providing specific advice to clients over the coming months.

If you would like to find out how the budget will impact on your finances, please get in touch to arrange your discovery meeting, provided at our expense,

Eliminating An Allowance

At present the amount of pension savings that can be accumulated by an individual is limited by both an “annual allowance” and a “lifetime allowance”.

As the names would suggest the “annual allowance” is a limit on the amount of tax advantaged pension savings and individual can make in a single “pension input period”, not to be confused with the tax year. This allowance used to be £255,000 per annum, which meant that it was not a concern for all but the most wealthy pension savers. Recent legislation has sought to reduce this allowance though, and on 6th April this year it will reduce to £40,000 per annum.

The “lifetime allowance” restricts the amount of pension savings one can accumulate in their lifetime. Any excess over the allowance carries a rather severe 55% tax charge. Like its annual counterpart, the lifetime allowance has been on the chopping block in recent budgets, falling from a previous £1.8m to £1.25m on 6th April 2014.

Some commentators are predicting that the government will announce the abolition of the lifetime allowance in the 2014 budget (at least for some individuals). This is one prediction which I do hope turns into reality.

It seems counterintuitive to limit an individuals lifetime pension savings, which are influenced by market growth and other factors over which they have no control, when we are already setting a limit on the annual pension input amount.

Surely it makes far more sense to simply limit the annual level of contributions, and stop taxing people on the growth in their pension funds. After years of increasingly complex pension legislation, any move to simplify things is surely a step in the right direction.

If you would like assistance with your own pension provision, please get in touch to arrange your discovery meeting, provided at our expense.

Buckingham Gate’s 2014 Financial Planning Thoughts

With the new year now underway, I thought it time to share our early thoughts on some of the key financial planning issues clients are likely to face in 2014.

 1. Re-balance investments

Given the fantastic market performance of 2013 both in the UK and abroad it is likely that many portfolios will now be out of balance when compared to the intended asset allocation. If left unchecked this can cause a large increase in the risk and volatility within a portfolio and could lead to larger than expected losses in future years. As such now would be a prudent time to review your financial planning goals for the years ahead and rebalance investment portfolios accordingly.

2. Plan ahead for pension legislation changes on 6th April

The 6th April 2014 sees the introduction of a reduced lifetime and annual allowance for pensions. The annual allowance is a limit on the amount of tax advantaged pension contributions an individual can make in a single “pension input period”. The lifetime allowance limits the total amount of pension savings you can accumulate in your lifetime. Any excess over these allowances can lead to large tax charges, which in some cases can be as high as 55%. This is a high priority area, which should be looked at well in advance of the deadline of 6th April. Clients who are members of a final salary or public sector pension scheme could be particularly vulnerable in this area.

3. Make considered use of tax allowances – Now!

Many people make use of their various tax allowances right at the last minute, especially ISA payments. In some cases this means that there is not sufficient time to complete the significant research required to make a suitable recommendation for investment and we are unable to assist. Furthermore, by leaving the use of these allowances to the very end of the tax year you are effectively losing out on a whole years worth of tax advantaged fund growth. Now is the time to start planning for the end of the tax year on 5th April and it would also be a great time to start planning for the 2014/15 tax year as well.

Some diligent individuals who have made full use of their ISA allowance since it’s introduction now have in excess of £1m sheltered away in a tax efficient home with no income or capital gains tax liability. For most this would make a most welcome addition to any retirement planning or investment goals.

4. If you are an employer – Start preparing for auto enrolment

While the new auto enrolment rules have already taken effect for the largest of employers, 2014 is the year where this new legislation will really start to impact on owner-managed business. Each employer will have an auto-enrolment staging date, this is the date on which a particular business will be required to comply with the new legislation. At an absolute minimum we would recommend that employers start preparing 6 months before their staging date preferably a year or more. If you would like an initial assessment of your auto-enrolment staging date and liabilities as an employer, please do get in touch.

5. Make the most of the low interest rate environment – While you still can!

While the low bank of England base rate is likely to persist for some months yet, the markets are starting to price in a rise in the benchmark interest rate within the next 18 months or so. This will begin to have an impact on the rate at which lenders can secure funds and In turn, this will start to filter down to mortgage rates. Clearly each individual will have different circumstances but in general those clients who have variable rate mortgages or borrowing may want to consider locking into the historically low rates currently available.  While no-one can say for sure exactly when a rate rise will occur, we can say with some certainty that the base rate will have to increase at some point from its current low.

6. Make a thorough financial plan

We all have different financial goals and objectives, however many of us are unsure as to exactly how or when those objectives will be achieved. Whether you aspire to retire early or fund a new business venture, by creating a comprehensive cash-flow model we are able to predict how close your existing provisions are to meeting your personal needs. As well as looking at the “ideal” scenario a cash flow plan will also enable you to consider your financial position in a number of “what if” scenarios such as the illness of a family member. This exercise is often eye opening and can show how well prepared (or not) you are for the financial challenges which life could throw at you.

By making time to sit down with a Chartered Financial Planner, you will be able to start 2014 with a suitable plan in place to ensure that you meet those all important financial objectives.

Don’t attack the wrapper – It wouldn’t hurt a fly!

In the hours after the chancellor’s autumn statement last Thursday, a number of media outlets ran a section where questions from the audience were answered by various personal finance commentators.

A re-occurring theme within these discussions were statements from the public such as:

“Pensions have rip-off charges” and, “I lost money in a pension”.

I would like to use my journal post today to dispel some myths about pensions and other tax wrappers.

A pension is simply a tax wrapper within which an investor can place a range of different investments. These are the same types of investments that are available either to purchase directly or within a different type of tax wrapper such as an ISA or investment bond. By purchasing investments through a pension those investments are afforded a range of tax advantages as follows:

• Income tax relief on contributions paid in
• Tax efficient fund growth
• 25% of the fund as a tax free lump sum on retirement

So to take the first of the comments above – Pensions do not normally have a direct charge for the wrapper itself. It would normally be the fund or other investments that are placed inside the pension wrapper which levy the charges so often referred to in the media. Some pension wrappers do carry a small annual charge on either a fixed or percentage basis but this is usually quite insignificant when compared to the charges for managing the funds.

It is worth pointing out that some investment funds do carry high (or even very high!) charges. Some funds, however, are very reasonably priced and offer real value for money to an investor.

Also of note is that the fact that a pension is not responsible for an investor losing money. Once again, it is the responsibility of the investments placed within the pension if a loss has been made.

Some investment funds do under-perform on a regular basis and are certainly not worth the annual management charge that they levy and could be considered poor value for money. Other funds perform very well and deliver real returns to investors without taking an undue level of risk.

The above is also true for other tax wrappers such as an ISA or an investment bond. It is not the wrapper that is responsible for charges or losses, but the investments we place within those wrappers.

A professional financial planner can assist you in choosing cost effective funds, keeping risk under control and generating a return so that you can achieve your objectives. They will also review those investment choices to ensure that they remain appropriate for your on-going needs while always taking account of costs and tax efficiency.

While the people who complained on the television the other night were rightly aggrieved, the wrong suspect had been blamed, for it was the investment, and not the tax wrapper, that was responsible for the losses and charges they were unhappy about.