Pension savers could slash IHT and become more tax-efficient
Pension saving is an endeavour which many people will embark upon for decades in the hopes of securing the retirement of their dreams. Tax-free cash can help savers as most will be able to take 25 percent of their pension value as a lump sum.
In fact, this is often seen as a vital part of a person’s retirement strategy and planning for the rest of their life.
Gary Smith, Financial Planning Director at wealth manager Evelyn Partners, has stressed the importance of when and how this cash is taken, especially given current high levels of inflation.
One key drawback is taking tax-free cash can cut a big chunk out of one’s pension savings earlier on in their retirement.
However, the expert did highlight three key benefits which could help many Britons later in life.
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Until reaching state pension age – currently 66 – many people may not have any other taxable income when they retire.
During this period, Mr Smith states it could be sensible to take action.
He explained: “The retiree might opt to take £16,666, via an uncrystallised fund lump sum payment, where 25 percent of the payment (£4,166) is paid tax-free, with the remaining £12,500 taxable income.
“However, as this income would fall within the retirees’ unused personal allowance, they should be able to reclaim any income tax deducted, enabling the full amount to be drawn tax-free.
“They could then repeat this exercise during subsequent tax years until the state pension commences.”
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Investment performances have been challenging recently, and consequently, the values of pensions may have fallen.
If the retiree were to take the full 25 percent lump sum now, Mr Smith states they could effectively “lock in” the reduced value.
Alternatively, individuals could only take part of their lump sum instead.
If the values of their pension were to subsequently recover in the following years, then they would have access to more tax-free cash.
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The goal of many individuals will be to pass on their wealth to their family, and legally avoid as much inheritance tax as possible.
It is worth noting pension funds currently remain outside of a person’s estate for inheritance tax (IHT) purposes, and this may influence a person’s decision-making.
Mr Smith added: “This might be important if the individual’s estate already exceeds their available inheritance tax allowances.
“If the individual were to withdraw their full tax-free cash, and simply deposit it or invest in another savings vehicle, then those funds might become subject to 40 percent inheritance tax.
“Therefore, only accessing the lump sum when it is required can be beneficial for IHT purposes.”
Ultimately, the decision on when to take tax-free cash out of a pension is one which is down to individual choice.
Mr Smith concluded: “The question of whether to take the 25 percent tax-free cash from a pot all at once or in instalments is a very individual decision, with no one-size-fits-all answer.
“But many savers are not, or only vaguely, aware of the option to stagger withdrawals and its benefits, so there might be a bit of a knowledge gap to fill.”
Consequently, some individuals may wish to seek guidance through the Government-backed PensionWise service.
Others may want to seek their own independent, regulated financial advice.
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