Pension – Tax Benefits
Back in 2006, something known as ‘A-Day’ was supposed to be the moment when – ‘once and for all’ – the rules for pension saving were simplified and everyone would be able to work out how to make the most of their retirement arrangements. Sadly, that dream has proved elusive – successive governments have continued to tinker with the regulations and it is therefore quite understandable you might feel a little overwhelmed by the complexities.
Nevertheless, despite all the changes, pensions still represent one of the most tax-efficient ways for most people to save for retirement.
WHAT IS A PENSION?
At its most basic, a pension is simply a savings scheme that offers very attractive tax benefits if you agree not to touch the proceeds until you are older. In other words, you hand over your money, that money is invested, its value (hopefully) grows and, at the end, you withdraw the proceeds and use it to pay for goods and services. In this case, however, you cannot touch the proceeds until you are at least 55 – and, under the current rules, you are restricted in terms of what you can do with the proceeds once you reach that age.
It may feel as if the rules on pensions can change with the seasons but some basic elements have remained constant in recent years. Investors receive income tax relief on their contributions into a pension scheme (up to certain limits) and the income and gains made by that fund accumulate free of additional tax while the money remains invested.
Under the current rules, anyone who withdraws all the money from their pension pot will have to pay tax. However, up to 25% of a person’s pension pot can be taken without having to pay any tax while, with regard to the remainder, there are four options:
- You could choose to purchase some form of annuity in order to secure a fixed, regular level of income.
- ‘Capped drawdown’ allows a person to draw income from their pension, subject to a maximum annual allowance of 150% of an equivalent annuity.
- ’Flexible drawdown’ allows unlimited withdrawal of cash from a pension pot but the person must also be able to show they have what is known as a ‘secure income’ of more than £12,000 a year.
- Those aged 60 and over with total pension savings of less than £30,000 can take the entire amount as one lump sum – a process known as ‘trivial commutation’. Any pension pot worth less than £10,000, meanwhile, is regarded as a ’small pot’ and up to three of these can be taken as a lump sum, regardless of a person’s total pension wealth.
However, the rules are changing. From April 2015, anyone aged 55 or over can take their defined contribution pension pot in whatever way they wish – regardless of its size – subject to their marginal tax rate and to the pension provider’s rules. 25% of the pot can be taken as a tax-free lump sum. Those who wish to buy an annuity will be able to do so but others might opt to keep their pension invested and take an income from it.
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