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Pensions are complex, but the last thing people want is to have to pay a 55 percent tax bill after working hard all their lives to save for retirement. Amy Pethers, financial planner at wealth manager RBC Brewin Dolphin said with a bit of forward planning, people can avoid being hit with a harsh 55 percent tax on their retirement income.
The pensions lifetime allowance, or LTA, caps the maximum amount Britons can save across all company and personal pension schemes at £1,073,100 for the 2022 to 23 tax year.
Ms Pethers said while this is not a maximum cap on pension savings, people could be hit with a tax charge of 55 percent on any amount above this.
She explained: “You can save more than this into a pension, but you may face a tax charge.
“The amount of tax you pay depends on how you draw the money and can amount to 55 percent on the excess if you take it as a lump sum or 25 percent plus your annual rate of income tax if drawn as an income.”
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To avoid this, she reccomends working out a plan to create a tax-efficient drawdown strategy with an independent fianncial adviser.
The expert also said it’s important to withdraw only what is needed. She explained: “If you take several large sums from your pension over a few months, this may push you into a higher-rate tax bracket and you could temporarily be subject to emergency tax as HMRC may think you plan on doing this for the rest of the tax year.
“It often makes more sense to spread the cash that you take form your pension over the months and proceeding years so that you have clear plan in place cognisant of the tax that you will be paying.
“Being realistic about what you need to live on is key, ensuring you have the right balance to enjoy your retirement but also be mindful to stay within the tax thresholds.”
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She continued: “For example, withdrawing less than £50,271 from your pension (and any other income sources) will ensure you only pay tax at a basic level of 20 percent.”
“However, if you withdrew £50,271 or over you would move into the higher tax bracket. The benefit of pension drawdown enables you to vary your retirement income from year to year.
“Which allows you keep it within a certain threshold. You should also think about what other assets you have available, for example, if you have sufficient savings within your ISA you can withdraw this as tax-free income without impacting your tax bracket. This is one reason why ISAs alongside pensions can be very useful in retirement.”
Understanding ones pension and the 25% tax free cash rule is also important and some people may have a more generous allowance than this.
Ms Pethers explained: “The headline rate of pension tax-free cash is 25 percent, but some pension savers with older style company pension schemes may find that they have a greater amount of protected cash available.”
Yet many people in these occupational schemes often forget that they are eligible for this.
“It is always worth enquiring about your pension’s benefits, rather than assuming they are the same as other schemes.”
Benefits taken before age 65 may be subject to a penalty, but might be worth it for some people.
Ms Pethers continued: “If you take benefits early from a defined benefit (or ‘final salary’) scheme, there could be a reduction in available income.”
“You would be getting a lower pension, but for a longer period.
“This could, for example, potentially put you in a lower rate tax bracket, or bring benefits below the lifetime allowance.
“However, you might want to consider what other savings you could access first, such as ISAs or other investments.”