What's new with pensions? By Rachael Tucker of Mitchells Chartered Accountants.
Pensions - we don’t understand them, worry that they are out of our control or we don’t want to think about them at all but the reality is that there are many tax benefits available to you if you contribute sooner rather than later and these exist to entice you into saving for your retirement. In the budget announced earlier this year George Osbourne declared that this will be “the most far-reaching reform to the taxation of pensions since 1921” and further guidance has now been issued.
Under the current rules, any contributions paid into your pension from earned income such as from being a self employed farmer can benefit from tax relief at the highest rate subject to a maximum of £40,000. When chosen retirement age is reached (for a farmer this is open-ended!), 25% of the pension fund can be withdrawn tax free whilst the remaining fund can be used to provide taxable income.
Under the proposed reform, there will be no changes made to the tax relief available when you pay into your pension and you will still have the option to extract the 25% tax free lump sum.
The major change is that from April 2015 investors aged at least 55 will have total freedom over how they take an income from their pension and could even take the whole fund as a lump sum if they so wish without incurring a 55% tax charge. They will then be able to use these funds as they prefer, remembering that the amount withdrawn will be taxed as income in the tax year of withdrawal. So where a large amount is withdrawn and this takes the pensioners’ income over the higher or additional rate of tax, the proportion that falls over the income bands thresholds will be taxed at 40% or 45%. Therefore in a scenario where a pension were to be drawn down and a buy-to-let property purchased then this would inevitably incur the higher or additional rate of income tax and this is no different if you buy land or a lamborghini! However, you can choose to take the pension out in stages, rather than in one go, which could aid in tax planning.
Another change is the abolishment of the pension income drawdown limits, which means pensioners can withdraw how much they wish in a year straight from their pensions. This used to have an annual maximum; however there is a risk of poor investment and ultimately running out of money in retirement. When a farmer reaches pension age they usually remain a partner in the business and therefore receive their share of taxable profits. While they still receive this income, the increased flexibility in pensions mean that they can vary their pension drawdown and therefore plan to minimise their tax exposure.
This capacity to withdraw any amount from the pension fund after the age of 55 may encourage those nearer this age to use their pension fund as a savings medium; however the restrictions on withdrawal before reaching retirement age tend to deter further investment. Savers often prefer the safety of a tax exempt ISA to which they have free access rather than pay additional sums into a pension fund.
After April 2015, if you start withdrawing from your pension, you can still make pension contributions up to a reduced annual allowance of £10,000 per annum, however this comes with the added hitch of a couple of exceptions.
The retirement age is also changing and will rise to 57 in 2028 which is the age at which you can choose to draw your personal pension; this will then rise in line with the state pension age.
The chancellor would like to ensure that everyone has access to impartial advice on the choices they face when arriving at retirement and this will be provided for free by organisations such as the Money Advice Service and The Pensions Advisory Service.
One thing still unclear is if there will be a reduction in the tax charge (currently 55% if you are in drawdown or over 75) paid on pension lump sums when you die. More guidance is due to be provided on this in the chancellor’s autumn statement.
If you would like any further information on anything in this article or information on the practice please contact Rachael on 01823 333813 or via email firstname.lastname@example.org
I am excited to announce that the official Mitchell’s App which is offered for Apple and Android devices is now available. It’s a completely free App and allows you to access tax tips and even has a pension relief calculator so don’t forget to download yours today!