You will be able to access the money in your pension once you reach age 55. Thanks to the “pension freedom” rules introduced by the UK government which came into force in April 2015, there are no longer any restrictions on the amount that you can withdraw from your pension, so you can withdraw as much or as little as you like. This is now known as “flexi-access drawdown”.
Whenever you make a withdrawal from your pension, you crystallise part or all of the money within your pension. This often means that within your pension, you can hold crystallised funds and uncrystallised funds. If you have never taken a withdrawal before, your pension will consist of entirely uncrystallised funds.
This is the part of your pension that hasn’t been accessed yet. You can usually withdraw 25% of this part tax free.
This is the part of your pension that is in drawdown and any withdrawals from this part will be subject to tax through PAYE.
Up to 25% of your pension can be paid as a tax free lump sum. This can often be called the pension commencement lump sum (PCLS) or simply just ‘tax free cash’.
You don’t have to take the full 25% all in one go, you can choose to take this in stages so not to use up your full allowance if it’s not required all at once.
John has a pension fund of £100,000. He would like to take a tax free lump sum but doesn’t require 25% of his whole fund.
Instead, he only wants to withdraw a tax free lump sum of £10,000. This means he would crystallise £40,000 of his pension, with 25% (£10,000) paid to him as a tax free lump sum. The remaining £30,000 would then remain invested and form part of his crystallised fund.
He would still have £60,000 in his uncrystallised fund which remains invested and continues to grow, and can take 25% of this tax free whenever he wants.
Using the uncrystallised funds pension lump sum (UFPLS) rules, you can take lump sums from your pension without crystallising your whole pension.
As the name suggests, you can only take a UFPLS from uncrystallised funds. Each withdrawal will be 25% tax free, with the other 75% treated as income and subject to tax.
Jane has a pension plan with a value of £75,000. She would like to take a lump sum withdrawal from her pension, but doesn’t want to use up her full 25% tax free allowance in one go.
She therefore decides to take a UFPLS withdrawal of £10,000. 25% of this (£2,500) will be paid tax free, with £7,500 subject to income tax. She would then have a remaining uncrystallised fund of £65,000.
This is where you draw a regular income from your pension, much like a monthly salary for your retirement. After all, pensions were originally intended to be used as a way of replacing your working salary to provide you with an income throughout your retirement.
The money is drawn from your crystallised fund and will be treated as income and therefore subject to tax.
The amount and frequency of the payments can be changed to suit your circumstances, they are not set in stone. Some years you may want to take more or less income than other years.
You will be able to decide how often you receive the payments and can usually be set up to pay you a regular income an a monthly, quarterly or annual basis.
Joe has a pension with a value of £300,000 and he hasn’t previously taken any withdrawals. He decides that he would like to take the full 25% tax free lump of £75,000 with the remaining 75% going into his crystallised fund to provide an income. He decides to draw a monthly income of £1,000 per month from the crystallised fund. The income is taxed at source by the pension scheme.
Historically, most people used their pension pot to purchase an annuity policy from an insurance company which paid them a fixed income for life.
In fact, before the pension freedoms in 2015, when you reached age 75 you either had to purchase an annuity or go into income drawdown, those were the only options available.
An annuity is a policy that pays you a guaranteed income for life. The amount you receive depends on a number of factors, such as your age, state of health and the choice of add-ons such as index linking or a spouse’s pension.
Generally, once you set up an annuity, it cannot be changed and the policy will remain in force for the rest of your life.
There is no longer any requirement to convert your pension into an income. You can leave your pension untouched without ever drawing a penny.
Money held in a pension scheme is not subject to inheritance tax in the UK and therefore can be used as a tax efficient way to pass on wealth to future generations.
When a beneficiary inherits a pension fund, they have the option to keep the money in the pension plan or withdraw it.
If you die before the age of 75, any withdrawals that your beneficiaries take from the pension will be tax free. If you die after the age of 75, any withdrawals paid to the beneficiaries will be treated as income and taxed at their marginal rate.
If you’re not resident in the UK, the income payments you receive are normally treated as income by your country of residence and the tax authority will usually want to tax you on this.
To prevent you paying tax in the UK and in your country of residence, the UK has agreed tax treaties with over 100 countries which avoids you being taxed twice on your pension income.
Contact us to discuss how you can use one of these tax treaties to minimise the tax you pay.
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