- Recent changes in pension regulations have been very positive. The fact that one does not have to take an annuity or go into drawdown at age 75 is very useful for people that don’t wish to be taking money from their pension pot, just because they have a birthday! The fact that you can still take your 25% tax-free cash at any time is also good.
- The problem with all this, however, is that you can take the 25% tax-free cash from your pension in a similar way that you can take money from your ISAs and in both cases, it comes without a tax liability.
- But in reality ‘only for that moment’. As soon as you take those funds and assuming you don’t spend them immediately, they re-enter your estate and they will become subject to all annual taxes (Income Tax on income and Capital Gains Tax on profits) but importantly also ultimately for 40% Inheritance Tax (if the funds are still in your estate at the time of your death).
- The 25% could stay in your pension fund but if you then subsequently die, which of course we all will, your beneficiaries will then not be able to take that 25% tax-free. This is because the whole of the pot following your death from the age of 75 will be available to your nominated beneficiaries, but they will pay tax at their marginal rate on any funds accessed, which of course could be quite punitive and likely be at least 20% and more likely 40% (and following Jeremy Hunt’s recent moves could even be 45%).
Ways to ensure tax free cash remains free of tax
- In spite of these changes there are steps to take to get around this risk, so that the cash can indeed effectively continue to be genuinely tax-free, even for future generations if the children themselves have potential IHT liabilities.
- An alternative to this is for the pensioner to take the full 25% tax-free cash (pre-75 or shortly thereafter, if your pension administrator so allows) but then immediately gift it into a discretionary, reversionary family trust. This will make it available to the wider family as and when needed. This can be done so long as the gift into trust is within the pensioner’s then available Nil Rate Band (NRB) for IHT (currently £325,000).
- Of course, such a gift is an IHT chargeable event itself, but with no immediate cost if within their NRB. It only becomes ‘potentially’ chargeable retrospectively if the pensioner dies within 7 years of making the gift. After survival for those 7 years the gift falls out of account completely. Result no IHT.
The conclusion is clear
- Taking the tax-free cash allowance before aged 75 is generally considered to be extremely sensible since subsequent withdrawals from that part of the ongoing fund, as with the rest of the fund, would otherwise incur Income Tax at the recipient’s marginal rate.
