The Easter Bunny Delivers Pension Reforms…And Warnings

The Easter Bunny Delivers Pension Reforms

Happy Easter everyone!! We hope you enjoyed the well earned break and rest.

Over the weekend, not only did we see the end of the tax year, the arrival of friends and family and the delivery of copious amounts of food, drink and Easter Eggs, we finally saw the introduction of the pension reforms that Chancellor George Osborne originally announced in his 2014 Budget speech regarding access to pensions.

We intend to cover the options in more detail in subsequent articles. And let’s be clear, that old saying ‘the devil is in the detail’ has never been more pertinent. However, as a starter, we think it important to extoll the virtue of forethought and professional advice in the context of these new rules. Well we would say that we wouldn’t we but it is true. Let us explain.

An article posted on the BBC website only last week titled ‘Pension withdrawal could mean tax shock, warns IFS’ lead with the tag line ‘Hundreds of thousands of people are being warned about a big tax bill, if they decide to cash in their pension pots from next week’. What are they talking about? Well let’s start at the beginning.

The standard rules permit 25% of an accumulated fund to be taken as a tax free lump sum. From the remaining pot individuals can then derive pension benefits. This used to generally be income but can now, under the new rules, be income, lump sums or any combination of the two. Regardless of the permutation, these will be taxable benefits.

Under Uncrystallised Fund Pension Lump Sum (UFPLS), any lump sum will be deemed 25% tax free and the remaining 75% taxable. Under Flexi Access Drawdown, it can be tax free cash only, taxable lump sum only or part tax free / part taxable as noted above. Tax planning is potentially, therefore, an even more important part of retirement planning than it has been previously. This is not simply just to ensure one utilises their personal allowances and or basic rate thresholds effectively, as has always been the case, but to ensure that the right kind of benefits are taken at the right time.

An already overlooked fact of the real world application of the new rules is that the amount of tax taken at source from taxable benefits, particularly lump sums, may be disproportionate. This is because such lump sums will be taxed under the PAYE system. Therefore, an individual encashing a small £30k taxable pension fund within the first month of the tax year may find a significant amount of tax being deducted as the system will ‘think’ they are taking £30k each and every month. The Income Tax due on £360k is far greater than the tax on what in reality may be a sole payment of £30k during the entire tax year.

The Government profess that such excess tax deducted may, subject to receipt of the correct applications, be refunded within a month. Call us sceptical but I suspect that this may not be the case once the flow of refund applications has commenced.

This not only highlights difficulties in planning for a specified ‘net’ amount, regardless of whether advice is sought, it also raises perhaps the more important issue of fund maintenance, where partial encashments are being taken. Fund maintenance is usually a highly important aspect of the underlying investment planning associated with Income Drawdown plans. But if the wrong type of benefit is drawn, it could lead to unnecessary tax eroding pension funds much quicker than would have otherwise been the case. The tax associated with pension freedom and flexibility could be considerably greater than the cost of fees associated with seeking professional advice.

In the alternative context that has been popularised within the media in recent months, potentially avoidable tax will make that supercar purchase considerably more expensive than it already is.