30th August 2017 at 7:00am
Pensions have become a lot more interesting thanks to recent changes, giving you more choice over how you take your pension savings from the age of 55.
And that means exciting new opportunities for how you can spend the savings you’ve built up.
The upshot is more of us are using pensions as a tax-efficient way of saving for our future – boosted by the growth in workplace pensions and the benefit of tax relief. And it means more of us are likely to build up pots of £1m-plus as we save into them for 30, 40 years or more.
It’s certainly good news for having the money to do what you want. It’s your choice whether you want to spend it on touring the world, or be sure that you’re likely to have enough to last your retirement and still pass money on.
But when it comes to tax and making the most of your money, there’s a bit more to think about.
The lifetime allowance – don’t think of it as a limit
Don’t think of it as a ‘limit’, it’s just a point at which the tax treatment changes. When your pension savings are worth over £1m you may have to pay the lifetime allowance tax charge on a slice of your money.
It’s really no different to any other allowance such as the personal income tax allowance, annual capital gains tax allowance or the dividend allowance: once you go over a certain point, a tax applies.
But if you are already over the lifetime allowance, or could be with growth on your existing savings, should you continue to save into your pension or look to alternatives? Your choice will very much depend on your personal circumstances.
For example, if you’re in a workplace pension you may want to continue saving into it so that you’d still benefit from any pension payments from your employer.
When do you pay it?
You only pay the tax charge when you start to take pension savings over and above the £1m allowance. It’s not something you automatically pay when your savings reach that figure.
How much is the tax?
There’s a bit of a myth around this that the charge is always 55%. The tax charge on savings above your allowance is 25% if you take your savings as income. If you take them as a lump sum, the charge is 55%.
Of course, you’ll also need to pay any income tax due when you take income from it.
Getting advice on how you take your retirement income and using your tax allowances can really help to reduce the total tax you pay.
It’s worth highlighting that any savings above £1m allowance can’t be taken as part of your tax-free cash.
Work out whether your savings will reach that magic figure
It makes sense to get to know your pension – or pensions – so you can keep track of how much you have.
Your pension provider should be able to let you know what you’ve saved and what your benefits might be worth at the age you plan to start taking your pension savings.
If you have an adviser, they’ll be able to guide you through how your fund might grow, looking at your payments and market performance and give you some idea of what tax you may have to pay.
The welcome news is that the lifetime allowance will be inflation proofed from next year, although this could change in future.
If you reach £1m, would you be better saving elsewhere?
It’s a good question, and the answer really depends on your circumstances.
Save into a pension and you usually get tax relief and save on National Insurance. When you save into a workplace pension, employers often offer other valuable benefits such as life insurance on top of their payments.
Things to consider: Reaching 75 is a milestone
Things change when you reach the age of 75. At this point you may have to pay the lifetime allowance charge on any of your remaining pension funds.
…and if you don’t spend all your pension
When you die, you can usually leave any pension savings you haven’t spent to your loved ones.
If you die before age 75, there may be a lifetime allowance charge on some or all of your remaining funds. But once it’s been paid, the balance of the funds can usually be taken by your beneficiaries free of income-tax.
If you die after the age of 75, there are no further lifetime allowance charges to pay and your named beneficiaries are taxed on withdrawals at their rate of income tax. This could be 20, 40 or 45%, or no income tax if it’s within their personal allowance.
Plus, your pension savings won’t normally be included in your estate for Inheritance Tax.
What are your next steps?
We know there’s a lot to think about when it comes to understanding tax and your pension if you’ve savings of more than £1m.
Talk it through with your adviser if you have one to plan the most effective way to manage your money, and pass more of it on tax efficiently. If you don’t have one you can find one at unbiased.co.uk.
As with any investment, the value of a pension can go up or down and may be worth less than what was paid in.
Laws and tax rules may change in the future and your own personal circumstances will have an impact on tax. The information here is correct as at August 2017