Fearless pensioner refuses to grow old
Hunt has quietly set a cap on the amount of total tax-free cash pensioners can withdraw and this will cause increasing damage to savers through a process known as fiscal drag. This happens when tax thresholds are frozen while asset values rise. It’s a common stealth tax trick.
Pension provider and financial adviser Quilter has warned the new cap is unlikely to rise now that it’s been set and this could shrink the value of the 25 percent tax-free cash for those with larger pension pots.
They risk losing thousands of pounds in tax to HM Revenue & Customs if they fail to take action.
In his March budget, Hunt abolished the pensions lifetime allowance, which capped the total amount savers can hold in their pension pots at £1,073,100, with a brutal 55 percent charge on savings on top of that.
The aim was to encourage NHS doctors to work on later in life, as many had retired early to escape the penalty.
It drew criticism from Labour who claimed Hunt was handing a tax break to the super rich, but critics failed to notice that the Chancellor had sneakily set a new maximum cap of £268,275 on the tax-free cash element for everyone.
Roddy Munro, head of tax and pensions specialists at Quilter, said this may only affect a small number of savers today but could have “major knock-on consequences” for pension planning further down the line. “More and more savers will see their tax-free cash shrink as their pension grows.”
Over five years those with larger pension pots of more than a million pounds today could lose nearly £37,000 of available tax-free cash as the value of their pot rises while the new cap doesn’t.
Their 25 percent tax-free cash will have fallen to 19 percent of their pot in that time. After a decade it will be worth just 14 percent of their pot, at a cost of almost £70,000 in extra tax.
This could hit around 1.6million pension savers in the next three years but their numbers will rise over time. These will be primarily those in defined benefit “final salary” company schemes, who may now face a tough decision.
One option is to withdraw the tax-free cash while still within that £268,275 threshold, if in danger of exceeding it.
However, withdrawing money from a pension before it’s needed isn’t ideal. Pensions offer attractive inheritance tax benefits, as they are not subject to IHT.
Once the money is withdrawn it will fall into your estate and may become liable to IHT when you finally die.
Another drawback is that once tax-free cash is withdrawn, any future growth on the money becomes taxable.
Munro suggested that pensioners consider using their tax-free £20,000 Isa allowance to shield ongoing returns.
There’s another option that has fallen out of favour but now has added benefits.
Munro says: “Offshore insurance bonds are back in vogue following these reforms. They can help to control the tax payable, simplify tax reporting and sit within a trust for IHT-planning purposes.”
Offshore bonds are tax compliant if done properly but they can be complex so it may be worth talking to an independent financial adviser to see how they could work for you.
Pensions tax could become an even bigger issue if Labour wins the next election, because it has vowed to restore the lifetime allowance.
Plus there is always the danger that the Treasury will scrap tax-free pension cash altogether, although that would be a highly unpopular move.
Tax-free cash is a great benefit and many use it to clear their mortgage and other debts, or fund big-ticket items such as a new car, home improvements or dream holiday.
Even those with more modest pension pots need to plan their tax-free withdrawals carefully, said Dean Butler, managing director for retail at Standard Life. “Savers have to decide whether to take it all in one go or split withdrawals into chunks.”
Taking smaller, regular chunks over the years can save tax compared to taking the whole lot in one go. “Once you have used your tax-free cash, any further withdrawals will be added to your income that year may be subject to income tax.”
Tax-free cash is a brilliant perk. No wonder politicians can’t keep their hands off it.
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