23rd May 2014 at 8:33am
Are you pleased with the Budget changes to pensions? From April 2015, you might have more flexible access to your savings.
For some, however, this flexibility could be a double-edged blessing : with flexibility comes choice and more things to consider. And there are income tax pitfalls to watch out for.
At the moment, people who are using flexible drawdown with a SIPP have this sort of control and flexibility – and it could be coming your way from April 2015.
So, how might you make the most of flexible income and realise the benefits which go with that? And are you aware of the income tax thresholds which might be relevant for your decisions?
The role of income tax
It was clear from my Budget Day blog that many readers had already twigged that there was a penalty to pay in withdrawing more income than you might really need from your pension.
They had their eye on the starting point for 40% income tax.
In tax year 2014/15, you start paying 40% tax on income above £41,865. The first £10,000 of your income is tax-free, thanks to the increased personal allowance. Then the next £31,865 is taxed at 20%.
Managing your pots to optimise your income position
So what do these income thresholds mean for how you might plan ahead with your pension?
First off, there’s tax free cash to keep in mind.
The first 25% of your pension is tax free. And with some pensions, you don’t need to take this all in one go. You can take it gradually.The first 25% of your pension is tax free. And with some pensions, you don’t need to take this all in one go. You can take it gradually.
Then, you have the personal allowance which is tax-free – £10,000 in 2014/15. After that, there are the limits mentioned above where 20% and 40% apply. There is also a 45% tax rate for income above £150,000. You might choose to take income at a specific level, with an eye on the tax thresholds.
If you have a selection of pots, however, it makes sense to plan how you’re going to combine their use most effectively.
You also need to factor in the pension income you can’t ‘turn-off’ or control so easily. For example, this includes pension income from a defined benefit pension, or the State pension (although you can defer taking the State pension and enjoy an increase as a result – there’s more information here.)
If you have an ISA, there’s no tax on withdrawals from it, so you might top-up your income using ISA withdrawals in certain years, for example.
And if you have an investment bond, there’s no immediate income tax to pay on withdrawals which use the 5% tax deferred facility.
Pots, tax and planning ahead
If you’ve saved well over the course of your working life, and moved around different jobs, you could have a number of pension pots by the time you reach your 60s. To help you control how you take your income, it might be an idea to bring those pension pots together as a tidy-up exercise, so you can keep track of your income plans.
This would make it easier and faster to arrange your income and change your income, if you’re keen to manage your finances to make the most of the 20% band.
If you have an ISA, there’s no tax on withdrawals from it, so you might top-up your income using ISA withdrawals in certain years
And when the time comes, it will be easier for your family to have one pension company to deal with instead of a handful of pension providers.
We’d recommend you speak to an expert to get guidance on what’s right for you, as you want to make sure you’ve thought about any important guarantees you might be giving up on pensions if you move them.
But having a clear line of sight over your savings is the starting point to make the most of the new rules, so you can act to ensure you don’t sleepwalk into a tax bill by mistake.
This blog and any responses to comments should not be regarded as financial advice. A personal pension, ISA and investment bond are investments. Their value can go up and down and may be worth less than you paid in. Tax rules and legislation change.
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