Between Covid, recession and Brexit, many of us may be thinking about giving up on the stress and strain of working and looking at early retirement.
The good news, if we are 55 or over, is that it could be possible to do so – if we have enough in our pensions. But making the wrong move with your pension now could mean that the taxman takes a sizable share of it.
At Continuum, we are looking how you can avoid the pension tax implications – whatever your current age and retirement plans.
Are you getting your full tax relief?
The first tax implication to avoid applies to everyone – not just those nearing 55. When you save into a pension, the government saves with you in the form of tax relief. Tax relief is paid on your pension contributions at the highest rate of income tax you pay. So basic-rate taxpayers get 20% pension tax relief, higher-rate taxpayers can claim 40% pension tax relief and additional-rate taxpayers can claim 45% pension tax relief.
If your contributions are paid by your employer before you pay tax, then you don’t need to do anything. Your scheme should be getting full tax relief.
However, if you pay your contributions into a private pension scheme you will only be getting 20% by default and need to reclaim any higher or additional rate tax.
You can claim this using your self-assessment tax return or by calling HM Revenue & Customs. Check you are getting the relief you are entitled to – you can claim any missing relief up to four years back.
If you are thinking about retirement – early or not – it pays to get the support of your Continuum adviser, who will be able help you see exactly what your pension pot contains – and the ways to make it work harder for you.
Don’t hit the pensions ceiling
You have an annual pensions allowance, which is £40,000 in the 2020-21 tax year, or 100% of your income if you earn less than £40,000.
If you exceed the annual allowance you will not receive pension tax relief on any contributions over the cap and you’ll be faced with an additional tax bill called the ‘Annual Allowance Tax charge’ (AA) For UK taxpayers (excluding Scottish taxpayers ) this is applied at the rate, or rates that apply to earned income i.e. 20%, 40% and 45%). This charge is added to your overall tax bill.
The Annual Allowance Tax Charge for Scottish Tax payers is charged at 21%, 20%,. 41% & 46%
(Because the lowest rate of AA charge is 20% this means that lower earning Scottish taxpayers will not pay any of the charge at the 19% starter rate)
This can be a problem if you want to make the most of your pension as you come up to retirement. However, pension carry forward rules allow you to use up to three years of unused allowances in the current tax year. So, if you didn’t pay the full £40,000 into your pension in previous tax years, you could top up to £120,000 in addition to this year’s allowance.
Beware too of the lifetime allowance, which is currently set at £1,073,100 – the maximum you can save into your pension.
Avoid the tax taper
Anyone with an income of £200,000 or higher could see their allowance drop as low as £4,000 under the pensions “tax taper”. One way to help avoid this might again be to use the carry forward rules.
Don’t step in the pension cash trap
Pension freedom rules allow you to withdraw up to 25% of your pension pot tax free. But once you have done so and you then draw funds from your pension pot thereafter, you will trigger the “money purchase annual allowance”, any which means the amount you can pay in with tax relief falls from £40,000 to just £4,000.
This was introduced by the Treasury to stop people recycling large sums of money through their pensions to benefit from the extra cash from tax relief each time. So if you want to make a one off purchase – to pay off a mortgage for example – and still want to grow your pension pot, you might be better off finding the money elsewhere.
Watch out for emergency tax codes
Calling on your pension pot for the first time can mean being hit by ‘emergency’ tax – especially if you call on a large cash sum.
This will trigger HMRC’s emergency tax. When you make a large withdrawal in one month, the taxman expects that to be repeated monthly across the entire year – so withdrawing £10,000 will mean being taxed as if you earn £120,000 a year.
You can reclaim the overpayment back on the HMRC website – but delays and frustration will be inevitable.
Get some help
Getting what you need from your pension can be complicated, whether or not you are bringing forward your retirement plans. Expert help is essential to avoid the traps.
At Continuum, we are experts in pension planning and management. Our Advisers monitor the markets continually and have up to the minute knowledge to help you review and update your plans. It means making the most of your pension pot now – and for the future.
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable retirement strategy, you should seek independent financial advice before embarking on any course of action.
The value of investments can fall as well as rise and you may get back less than you invested.
Levels and basis of reliefs from taxation are subject to change and depend upon your personal circumstances.
Accessing pension benefits early may impact on levels of retirement income and your entitlement to certain means tested benefits.
Accessing pension benefits is not suitable for everyone. You should seek advice to understand your options at retirement.
Your home may be repossessed if you do not keep up repayments on your mortgage