We recently published two pieces on Capped Income Drawdown, the first part took a look at this as an option and compared the current rules against those that applied previously. The second part examined the opportunities, advantages and disadvantages of Capped Income Drawdown, and where these may be appropriate for clients.
One opportunity that for some time was exclusive to Income Drawdown was the ability to take tax-free cash from your accumulated pension fund whilst taking no income. Indeed a number of clients for whom we have acted considered this for that very purpose. However, for some clients who may not need the income, it may be beneficial to do so.
Once an individual under the age of 75 takes tax-free cash from a pension fund, the fund has gone through what is termed a ‘benefit crystallisation event’. Immediately before this event, should an individual die, the pension fund would become payable, usually in full, to their beneficiaries indicated within the nomination or ‘expression of wish’. Very often this is a surviving spouse or civil partner. Importantly this death benefit is not subject to tax. However, as soon as the tax-free cash is taken, the death benefit changes. The fund, if payable as a lump sum, is subject to a tax charge of 55%. If of course this is not paid to a surviving spouse or civil partner, then the fund may be subject to Inheritance Tax (IHT) and consequently a further 40% tax may be deducted, resulting in a composite tax charge of 73%. Clearly an important consideration!
By definition, a decision to take no income is made because it is not needed and, as such, any income withdrawn would not only be surplus to requirements but would also result in an unnecessary Income Tax liability. Therefore, rather than taking no income, what are the consequences of taking income?
Providing this were redirected back into pension, this would be Income Tax neutral as any tax due on the income would be subject to Income Tax relief when paid into pension.
Prior to age 75, this would then accumulate a new fund that had not had a ‘benefit crystallisation event’ and as such would not be subject to the 55% tax charge.
Upon death, this would be outside of the estate for IHT purposes, thereby potentially avoiding an additional 40% tax charge.
Finally, from the new fund, the individual would be entitled to take a further 25% tax-free cash lump sum as and when they require benefits from the fund.
Of course, if someone has retired, they may continue to receive little or no earned income upon which pension contributions may be based. Irrespective of earned income levels, anybody may invest £3,600 per annum into pension. However, some clients may have taken tax-free cash from their pension for purposes such as redeeming their mortgage, funding a second property purchase or financing a business expansion for example. As a result, they may well continue to work and receive earned income.
This opportunity is not wholly exclusive to clients in Capped Income Drawdown. Indeed clients that have utilised an annuity to facilitate pension income that find it surplus to requirements could also consider this idea.
An important final note to make is that utilising this idea with a tax-free cash lump sum cannot be considered as recycling in this manner is not permitted.
Capped Income Drawdown pension providers have woken up to this idea and can provide quotations and indeed can often facilitate the recycling of surplus pension income within the same product.
Should you wish to discuss your pension income planning, please do not hesitate to contact us for an informal chat or meeting.