The pension trick that could get you a second tax-free lump sum of £13k and save your family £28k if you die
Pension trick: Doubling up on pensions can save you thousands in tax and get you an additional tax-free lump sum
Reinvesting unused pension income into a new pension scheme can save thousands of pounds in tax, according to investment firm Skandia.
It says that those who have taken pensions that they have left invested but do not need to fully draw on them for income could recycle their money to make tax savings.
Their analysis shows that someone with a pension pot of £150,000 entering income drawdown at age 55 and recycling unused income for 10 years could get themselves an extra £12,750 tax-free lump sum.
If they die with their pension still invested it could also save their family £28,000 in tax.
Data recently revealed by Skandia shows that 59 per cent of customers in drawdown are not taking an income.
These are people that have taken their tax-free cash, but have not started taking an income from the remainder of their pension fund.
The problem with this is that if they die before age 75, the remainder of their pension fund will be subject to a 55 per cent death tax charge.
This means that it cannot be passed on to beneficiaries tax-free. Part of this can be avoided by recycling pension income.
Plus the reinvested pension will provide a second tax-free lump sum, with retirees able to take as much as 25 per cent of their second pot as additional income. This is a benefit as pensions income after the tax-free lump sum has been taken out is taxed.
How the recycling works
Individuals under age 75 are able to pay contributions of £3,600 a year into a pension, and receive tax relief on those contributions, even if they have no earnings.
If someone is working, then they will be able to contribute even more, subject to the maximum annual allowance.
People in drawdown and not taking an income, could create new pension savings by taking an income from their existing drawdown fund to re-invest as a new contribution.
There is no net cost to doing this because the income tax paid when taking money out of the existing pension is offset by the tax relief received when the money is reinvested as new pension savings.
Doubling up: how this simple pension trick can keep more of your money away from the tax man.
If you take the example of someone aged 55 with money in drawdown of £150,000, assuming a growth rate of 7 per cent over a ten-year period, by the time they reach 65, their pension fund could be worth £203,000.
As the recycling simply involves withdrawing money and then paying it back in, the fund will grow to the same value regardless of whether or not they recycle unused pension income, says Skandia.
But if they took the £3,600 a year from their pot as income and re-invested it into another pension fund, a new tax-free cash entitlement would be built up. So over the 10 year period they could benefit from having £12,750 as an additional tax-free lump sum.
The amount of the drawdown fund subject to the 55 per cent tax charge if they died could also reduce from £203,000 to £152,000. This means beneficiaries could be £28,000 better off in the lump sum they receive if the pension holder were to die.
The longer you recycle the more you gain
The longer this recycling of income continues the greater the benefits.
Someone can continue to do this right up until they turn age 75, so, using the above example, there could be 20 years’ worth of income recycling, which could result in a substantial £34,250 tax-free lump sum.
Adrian Walker, Skandia’s pension expert, comments: ‘For those sat in drawdown not taking an income, there is an incredible opportunity to reshape their finances to benefit from greater tax efficiency.
‘Recycling unused pension income is not about building a bigger overall pension fund, it is about building a more efficient long term retirement solution – improving both the value of those savings to pass on to beneficiaries and the retirement income they receive.
‘The current economic environment has created uncertainty for many and people may take their tax-free cash, but be unsure of the best time to start taking an income, or which income route to choose. People in this situation should seek professional advice, as this procrastination could end up costing them thousands.’
Skandia was keen to stress that under HMRC rules, ‘recycling’ of unused pension income is allowed, but it is not possible to ‘recycle’ tax-free cash.
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