Despite the enhanced flexibility people will have when it comes to pensions from April 6th, it is necessary to be weary of the changes it will have for income tax.
The Treasury has released data predicting that after three years subsequent to the changes, they could be taking in an extra £1.2 billion a year from withdrawals of pension savings. They are set to benefit hugely from savers cashing in on their pots and also taking out money which amounts to more than their entitled amount to tax-free cash.
There are a number of rules and regulations to be aware of as we move into this period of pension reform. Firstly, every person is entitled to withdraw cash tax-free from their pension. This figure normally stands at 25% of the total value of the fund.
Withdrawals made that amount to above this figure are taxed as income would be and this pertains to the tax year in which you make the withdrawal.
An expert for Intelligent Pensions, David Trenner, commented on the new freedoms: ìAny withdrawal which is not tax-free cash will be taxed at up to 45%. In addition, if you take cash which together with your other income in the tax year amounts to more than £100,000, you will lose part or all of your personal allowance.î
However, there are a number of other qualifications to be aware of when deciding how to use oneís pension pot. The retirement director for Fidelity Worldwide Investment, Alan Higham, has highlighted these complications.
Mr Higham stated: ìRetirees will be liable for income tax on their pension withdrawals. But that is not how tax will be collected from most people by their pension scheme. In most cases, the scheme will be required by Revenue & Customs to tax from ad hoc withdrawals at a higher rate under emergency tax rules.î
He went on to say: ìPeople will then have to reclaim the overpayment from Revenue & Customs using forms P50 or P53. If they donít do that, they could wait a year for the taxman to give them a refund.î
A number of examples were offered up from Mr Higham in order to elucidate these new rules pertaining to pensions. In the example of a pensioner who has no other taxable income, and withdraws £30,000 from their scheme, they would end up paying £8,572 in emergency tax when in fact they only owe £2378. They would then have to complete all the necessary forms in order to retrieve £6,194.
Stephen Womack, who is a chartered financial planner has highlighted the tactic of staging oneís withdrawals across different tax years and thus reducing the cost of their tax bill.
He uses the example of someone with a total income of £20,000 per annum made up of a combination of salary, company and state pension. If that individual was looking to take cash out of a £40,000 pension pot, they could save £1523 on tax by taking half of it out in one year and the other half in the next tax year.
Mr Womack goes on to defend the notion of keeping oneís savings in pension schemes because of the new rules which mean pension funds can be passed on to descendents tax free. He went on to comment: ìIf you are under 75, and you have enough wealth for inheritance tax to be a factor, it makes sense to spend down other savings before drawing on a pension.î