Tax efficient pensions

It is well known that pensions can be a highly tax efficient means of saving for retirement, but is there anything more you could be doing to enhance tax efficiency further?

Pensions are in the news again, what with the black hole in the BHS company pension, and the news that some master trust schemes (which have been especially popular with employers falling within the Auto Enrolment legislation) have been criticised as being too small to survive, it becomes ever more important to ensure you are getting the best value from your pension arrangements. One way of mitigating tax on your pensions, and so enhancing the ultimate payout may lie in the exception available for “small pot” payments.

Taking pension benefits

Since April 2015 most of us on attaining our 55th birthday have had the right to access as much of our pension savings as and when we want. However, it’s rarely a good idea to take all the money from your fund in one go. Apart from losing the tax-free status which pension savings have there are other tax consequences.

Tax side effects

The most obvious consequence of taking a significant lump sum from your pension is that it’s added to your other taxable income (except for the first 25%, which is tax free) and might be enough to push you into a higher rate of tax. However, there’s a less obvious side effect.

Trap. Taking money, whether it’s all of your pension savings or just some it, will cap the amount of tax relief you can claim on future pension contributions – with some (limited) exceptions.

Tip. You’re allowed to take so-called small pots from your pension savings without it capping tax relief on future contributions.

What counts as a small pot payment?

A small pot pension payment is one which:

  • doesn’t exceed £10,000
  • is paid out of a pension plan that you have not drawn from already; and
  • uses the whole of the money in the pension plan.
  • The rules allow you to take up to three small pot payments during your lifetime.

How will it be taxed?

Small pot payments are taxed in the same way as other pension lump sums. The first 25% is tax free and the balance is taxed as income. The pension company will deduct basic rate tax (20%) from the taxable part of the payment before sending it to you. For example, if you took a pension pot of £8,000, you would receive £6,800, i.e. £8,000 less (£8,000 x 75% x 20%).

Trap. If you’re a higher or additional rate taxpayer you’ll have to pay further tax on the payment as the pension company will only have deducted the basic rate amount. However, if you time taking your pension small pot well, you can delay paying the extra tax by up to 22 months.

My pots are too big!

If none of your plans are worth less than £10,000, you might be able to reorganise them so that at least one is. You could transfer a plan worth, say, £18,000 from one scheme to two others equally. There may be a charge for this. A cheaper solution is to ask your pension company if it can divide a fund into separate smaller ones. There might still be a small charge for this, and not all companies will allow it, but it’s worth asking.

The next step

To take a small pot pension payment you must be 55 or over and the pension plan must not be worth more than £10,000. Plus you have to take the whole fund, not just part of it. If you don’t have a pension plan under £10,000 you can transfer a larger fund to two or more small ones and then take a small pot payment.

All Round Accounting Limited

T:            01825 729453



New Tax Year – New Rules

New tax allowances and rate.

You’ll probably know that new rules and tax rates will apply from 2016/17 to dividends and certain other types of investment income, principally deposit account interest and government stocks and bonds. There will be a dividend nil rate band (DNRB) and the personal savings allowance (PSA).

Since the rules were snuck in during the post-election budget (there were essentially 3 budgets in 2015!!), there has been confusion and misunderstanding surrounding how the new rules will affect the tax position across a broad spectrum of taxpayers.

Savings: The PSA is a maximum of £1,000 for basic rate taxpayers and £500 for those who pay at the higher rate. It’s zero for additional rate taxpayers.

Dividends: The DNRB is £5,000 for all taxpayers. These two new allowances don’t interact, i.e. each can only be used against the type of income to which it relates and neither affects the amount of the other you’re entitled to. However, where you use any of either allowance it also uses part of your basic rate tax band, so potentially, this could be pushing taxpayers into the next tax banding.

Tax planning. The introduction of the PSA raises a question over whether you should rethink your ISA investments. After all, if you can receive up to £1,000 bank or building society interest tax free why bother with an ISA (which have recently been offering paltry interest rates)?

  • ISAs still make good sense because you can build up significant savings on which all the interest is tax free. However, because interest rates on ISAs are usually low compared with, say, a high interest term account, it also makes sense to open one of these to take advantage of your PSA, especially if you’re a basic rate taxpayer.
  • Depending on your circumstances, there may be other relatively simple tax planning means by which you can generate interest income.
  • As regards Dividends, if, as a higher / additional rate taxpayer, you’ve been avoiding taking dividends as income now may be the time to look at restructuring your investments or your remuneration strategy to take full advantage of the new £5,000 DNRB.

All Round Accounting Limited