How flexible are your pension savings?
By Kevin McDaid, Aug 3 2016 03:09PM
You may be aware that from April 2015 new rules were put in place to allow pension providers to pay out pension plans to certain customers. These rules cover defined contribution pensions, more commonly known as money purchase schemes, but not defined benefit schemes, often known as final salary pensions. If you are unsure which type of pension you are paying into or want to know what you will be allowed to do, ask your scheme provider.
Previously, most people saved in a pension scheme and then used the funds to buy an annuity which provided them with a guaranteed income in the form of a pension. This is still an option, but it is no longer the only option. It is now up to the individual to decide how much and when they wish to withdraw from their pension plans. In theory, and whilst the money lasts, they will be able to take out as much as they like, whenever they like, from as early as age 55 years.
The three main choices available are:
➢ to withdraw all of the money in one go
➢ leave it in the scheme and take a regular or ad hoc income
➢ buy an annuity or enter into a drawdown arrangement
➢ A combination of all three.
Freedom for the way ‘Tax Free’ cash can be taken
Most people can already take up to 25% of their pension as a tax free cash lump sum. This remains the same, but from April 2015, how you choose to do this changed too. The options now are;
➢ Take 25% tax free in one go, meaning any subsequent withdrawals will be taxed as income.
➢ Take 25% of every cash withdrawal tax free, with the remaining 75% taxable as income.
So how will your lump sum be taxed?
The amount of tax you pay depends on your ‘other’ taxable income in the year you take your pension. As your pension provider will not know how much your other income is, they will be instructed by HMRC to operate an emergency tax code, 1100L for this, the 2016/17 tax year. This will result in tax being deducted as follows:
• the first £916.67 is not taxed
• the next £2,667.67 is taxed at 20%
• the next £8,916.67 is taxed at 40%
• and the remainder is taxed at 45%
Over the course of a tax year, these monthly rates translate as follows:
• the first £11,000 is not taxed
• the next £32,000 is taxed at 20%
• the next £107,000 is taxed at 40%
• Anything above £150,000 is taxed at 45%
• Between £100,000 and £122,000 the £11,000 tax free allowances are withdrawn resulting in an effective 60% tax rate. However, this is ignored for the purposes of this article.
The effect of this is best illustrated by way of an example:
Sally is due to reach 55 on 30/09/2016 at which point she decides she is going to retire and take the whole of one of her pensions, £40,000, in a lump sum. £10,000 of this will be tax free, leaving £30,000 taxable in the month of receipt. This will result in tax of:
• the first £916.67 is not taxed
• the next £2,667.67 is taxed at 20% = £533.53
• the next £8,916.67 is taxed at 40% = £3,566.67
• £17,499 taxed at 45% = £7,874.54
• Total tax deducted = £11,974.74
• Net receipt = £28,025.26 (including £10,000 tax free element)
If Sally’s only other income during the tax year was her salary at the rate of £3,000 per month until the end of September 2016 (£18,000), we can see that her total taxable income for the year is £48,000 which is way short of the £150,000 tax threshold at which 45% tax becomes payable. As Sally has paid almost £8,000 in tax at 45% she is clearly due a refund:
So how do you get a refund?
You may be able to reclaim it immediately using form:-
• P53z if you have taken all of your pension and have other income
• P50z if you have taken all your pension and have no other income or
• P55 if you have only taken part of your pension
These forms and additional information can be found at https://www.gov.uk/claim-tax-refund/you-get-a-pension or by calling 0300 200 3310. If you would rather not fill in one of these forms and are happy to wait, then HMRC should notice the incorrect tax deduction at the end of the tax year when they reconcile their records.
If the pension was being accessed say in February or March it may not be worth your time completing the relevant form because HMRC may do the annual review quicker than they deal with your repayment claim. Once the tax year has ended, if you believe you are due a refund but have not heard anything by the end of April, contact HMRC to bring it to their attention.
Unfortunately, HMRC will not release a refund of tax if an individual is required to complete an annual Self-Assessment tax return. Consequently, in the situation involving Sally, if instead of being employed she had been self-employed or was receiving rental income she would have had to wait until April 2017 at the earliest to complete her tax return and claim the refund.
What our clients said about us:
I have a portfolio of over 50 residential properties throughout the North of England.
I first came across Kevin in 2010 when he was performing capital allowances valuations in respect of houses of multiple occupation (HMO). At that point, not many accountants that I spoke to, had much of a clue about the ability to claim the allowances whilst many of those organisations who were in the know, were keen to do the valuations for a hefty fee but then really did not instil me with any confidence about the tax implications.
Kevin was different; we had an initial chat over the phone, there was no big sell and no hefty fee. Because he has a tax and surveying background, not only was he able to undertake the valuations he was able to liaise with my accountant to fully explain the tax implications and talk him through the reporting procedure.
There is no question that the tax savings I made hugely outweighed his fees.
Fast forward 5 years and there is no surprise that, once again, he seems to have a far greater understanding of the latest tax changes than the accountants of other landlords that I regularly speak with.
He has kept me fully updated on the tax implications of the loss of wear and tear and the changes in the allowability of loan interest. He has provided me with an in depth report showing how much post tax income I would have from the present day right through until 20/21 when the restriction is fully in force. It did not paint a pretty picture. In fact, I would go so far as to say, that I would almost certainly no longer be able to continue to operate as a property investor by 20/21 in a sole trader capacity. Consequently, as of 01/04/16, I am now operating as a limited company, Kevin guiding me and my accountant through the tricky incorporation maze and explaining the best profit extraction method going forward.
I would point out that we had been discussing the SDLT implications of incorporation on the run up to the Budget on 16/03/16. With over 50 properties this was going to be a hefty charge for me. We had anticipated there would be a relief for the transfer of more than 15 properties into company ownership. When it was announced in the Budget that this would not apply, Kevin contacted me on Budget day whilst I was in South America to break the news and to push for the transfer to take place by 31/03/16 in order to save an extra 3% SDLT, which I duly did.
Once again, big tax savings for reasonable costs but, most importantly to me, I know exactly where my business is going, how much money I can personally extract from the company & how much should be left in to help pay off existing mortgages or to expand the business.
It really is a no brainer to work with Kevin whether you are a large or small property investor.
We first used the tax services of Kevin almost 10 years ago when he was working for a local firm of chartered accountants. Having received an excellent service from him for a number of years (including expanding from a partnership to a limited company) we were delighted to hear that Kevin had set up on his own and had no hesitation in signing up as a client in 2012. He continues to offer a very personable and cost effective service. We would absolutely recommend him to any other small company like ours.
In addition to our company, we have a small residential property portfolio and were contemplating disposing of one of the properties in 2014/15. Had we not consulted with Kevin prior to the sale, we would have been facing an unwelcome Capital Gains Tax Liability. However, by transferring the property from sole into joint ownership we were able to benefit from a second CGT exemption which saved us almost £2,000’.
Mrs S (Company Director, Bingley)
I first met with Kevin in July 2015 because I was worried that I had been receiving rental income for 3 years but had not declared anything to the tax man. The reason I had not done so was because I had spent quite a bit doing it up when I first purchased it and, by my calculations, I had only just started to make a profit in the tax year ended 05/04/2015.
Kevin explained that not all the expenses would be allowable because some counted as improvements. He provided a fact sheet on ‘Revenue versus Capital’ indicating that those costs that counted as improvements would, ultimately, be available to set against any gains on disposal of the BTL. He also clarified the other expenses I was entitled to claim.
He calculated the net profit from letting. Even though no tax was payable he advised that the income still needed to be reported to HMRC which he duly did via a letter as, he said, the amounts involved were below the level for which a tax return was required. Apparently, this saved me penalties for failing to submit tax returns by the due date.
A tax return will be required for 2015/16 and I will be using Kevin to prepare this as, last year, he took away my concerns in sorting out my tax in a professional manner. He is not expensive and I feel comfortable dealing with him.
I would be happy to recommend him based on my experience.
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How flexible are your pensions savings?