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With the end of year tax season approaching on 5 April, what are the key tips for your pension fund?
With under a month to go until the end of the tax year, it is vital to understand how your pension is taxed. Below are five factors you need to consider before the end of the tax year, especially if you are considering withdrawing from your pension.
In the majority of cases, after you reach age 55 you are allowed to withdraw 25% of your pension tax-free. However, it is key to remember this is a one-off benefit, so you should consider how to utilise it efficiently.
Depending on how you take your pension income, you could withdraw this amount in a one-off lump sum, or you could do so in phases.
If you do not require immediate access to your funds, withdrawing your pension in phases may seem preferable. Not only does this generally work out to be more tax efficient but leaving larger funds in your pension for longer could help it grow.
If you decide not to use an annuity for your pension income, how and when you withdraw your money are the primary factors which determine how much tax you pay on your pension.
If you decide to withdraw all your money in one lump sum, 75% of this will be subject to tax laws. Depending on how big your pension has grown, this could push your income into a higher tax bracket for that year as the lump sum will be considered as taxable income. Moreover, you will have to consider how you can use these funds to maintain your lifestyle in retirement.
If you withdraw your pension gradually, there is the potential that your funds could continue to grow and add more to your retirement, although this is not guaranteed.
Whatever the case, we always recommend you evaluate all your options with a qualified financial adviser before making any decisions.
In addition to your tax-free income, you should be aware of the Lifetime Allowance and Annual Allowance for this year.
The Lifetime Allowance is the maximum amount that can be saved into a pension over someone’s life without paying tax. This figure currently stands at £1,073,100 and will be frozen for the next five years.
When you start accessing your pension by way of regular income, funds which exceed this allowance are subject to a 25% lifetime allowance charge in addition to any standard income tax. If your money is withdrawn in a lump sum, a 55% Lifetime Allowance charge will apply with no further income tax payable.
The Lifetime Allowance charge may also be payable if you pass away before the age of 75 without accessing your pension or if you do not access your pension before the age of 75This includes accessing a tax-free lump sum, a regular pension amount or placing the funds in drawdown.
By contrast, an Annual Allowance is the maximum you can pay into a pension which can be used for tax relief. This year that figure is the higher of your earned income or £40,000, so if you are looking to commit more funds be prepared to be taxed separately for this amount.
All pensions are considered a type of taxable income and are therefore may be subject to tax.
For most pensions, your tax is usually automatically deducted through a Pay As You Earn (PAYE) system with your other pension contributions. If your state pension is your only pension, you may have to complete a self-assessment tax return with HMRC.
Currently, if you have chosen your pension via a flexi-access drawdown and you die before the age of 75, your pension can be paid out to someone else tax-free. No matter what the conditions, you should not have to pay any inheritance tax when inheriting a pension, but you may be subject to income tax.
Our newly published guide has more detailed information on what happens to your pension after death.
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