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Pensions now tax efficient, even on death

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Thursday June 26, 2014 at 10:00am
There is one common bug bear with pensions; they are simply not tax efficient on death. The good news is with the new pension rules and careful planning this is no longer the case.

As the rules currently stand the treatment of your pension fund is different depending upon whether you have taken tax free cash. Let’s say you have a fund worth £500,000. If you die without having taken tax free cash your spouse or next of kin would receive a cheque for the full £500,000 tax free. However, if you had taken 25% tax free cash of £125,000 the remaining fund of £375,000 would be subject to a 55% tax charge on death, ultimately meaning your family are worse off.

How to minimise tax on pension on death

Firstly, the current 55% tax charge is under review and the feeling is that the government will bring this charge into line with the highest rate of income tax, i.e. 45%. Even so this is still a big hit.

Let’s say you want to withdraw £30,000 per year from your pension and the fund grows at 6% per year. The £30,000 withdrawn is replaced by the 6% growth in investments; hence the fund value remains at £500,000.

So instead of taking the full £30,000 as tax free cash what you may consider is taking 25% of the £30,000 being £7,500 as tax free cash and taking the remaining £22,500 as income. In this way the growth adds to the fund from which no tax free cash has been taken. The net effect is to take all of your pension income but still retain a £500,000 fund that will incur no tax charge on death.

What happens at age 75?

If you have not taken your tax free cash by age 75 you lose the tax free death benefits on any part of your pension fund that has not had tax free cash paid out. Hence the advice is there is little point in not taking your tax free cash once you reach age 75. However, all is still not lost as our advice would then be to combine a total withdrawal of pension fund, under the proposed new rules, with a tax advantaged investment that would shelter both income tax charged on pension withdrawal and be tax efficient for Inheritance Tax.

As you might have realised this is quite a complex area of pension and retirement planning so do take advice before acting on any of the ideas I’ve shared here. I’m always willing to discuss the options with you, just give me a call.

Andy Parker
Chartered Financial Planner, Solihull

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Parker Chartered Accountants and Financial Advisors is the trading name for PLW Advisors Ltd (Registered No. 10396831), and Parker Financial Planning LLP (Registered No. OC347027). Parker Financial Planning LLP is authorised and regulated by the Financial Conduct Authority. All companies are registered in England and Wales – registered office contact details here