Pensions are not like bank accounts after all!

Following the implementation of the pension freedom rules in April 2015, tabloid headlines have given us the impression that pensions now operate like a bank account.   Although pensions have become more flexible, the reality is that they cannot be treated as bank accounts.

Potential problems when considering withdrawing funds from a pension plan include taxation implications and reducing your ability to pay more into a pension.

When a pension withdrawal is made, in addition to the 25% tax-free cash entitlement, HMRC assumes that similar sums are going to be withdrawn regularly in the future.  For example, after payment of tax-free cash, a one-off £10,000 payment will effectively be treated by HMRC as though £120,000 is due to be taken (i.e. £10,000 x 12 months).  In most cases, too much tax will be deducted from the payment, resulting in a less than expected net withdrawal initially.  In order to obtain a refund, a form will need to be completed and sent to HMRC.

As covered earlier in this newsletter, the maximum amount that can be paid into a pension per tax year is £40,000.  There are often justifiable reasons for someone over the age of 55 to access their pension early, even whilst still working, but future ability to contribute to a pension should be considered if the amount being withdrawn is in addition to the tax-free cash entitlement as a lower annual allowance of £10,000 then applies.  Whilst that may offer sufficient scope for most people, having that sum reduced to £10,000 may leave some individuals with an unexpected tax bill.

In light of the pension freedom rules, another area for consideration is what happens to the pension pot on death.  Bank accounts form part of an individual’s estate, and such assets are passed to beneficiaries in accordance with their will.  

Pensions operate differently, however.  If there is no surviving dependent when a pension policyholder dies, the beneficiary will be at the pension provider’s discretion.  Although these rules provide new planning opportunities when passing on a pension legacy, individuals should give thought to the beneficiaries and to the tax implications for individuals who die after the age of 75.  Existing pension arrangements should either be written under trust or have an up to date Expression of Wish or Death Benefit Nomination in existence to ensure that benefits are payable in accordance with the policyholder’s wishes.

At Birkett Long IFA, we work closely with our colleagues in the wills, trust and probate team to ensure our clients receive ‘joined-up’ advice.  

The financial conduct authority does not regulate wills and estate planning.