Immediate vesting personal pensions allow individuals aged 55 to 75 (under current rules) to pay a lump sum into a personal pension, get tax relief on the contribution, then draw benefits immediately by taking 25 per cent of the fund as tax free cash and buying an annuity with the balance.
Guaranteed returns thanks to the tax man
This means that a 40% rate tax payer could, for example, pay £10.000 into a personal pension and then immediately withdraw £2,500 as a tax free lump sum. The remaining £7,500 would need to be used to generate a retirement income i.e. by purchasing an annuity.
The £10,000 contribution would only have cost the individual £3,500 in reality once you deduct the £4,000 tax relief they will receive as well as the £2,500 tax free lump sum.
Based on current annuity rates a 60 year could expect the £7,500 left in the pension to purchase a taxable annuity income of around £430 per annum. This is equivalent to a return of around 12% of the individual’s net outlay (£3,500). Consequently, IVPP’s are getting a lot of press coverage at the moment as people approaching retirement are being faced with historically low interest rates on savings accounts.
Drawbacks
The above course of action is not suitable for everyone and you should seek financial advice before making a decision as there are drawbacks to IVPP’s, which include:
- You lose your capital completely and, once you've bought the immediate-vesting personal pension, it can't be changed.
- The income from the annuity is taxable.
- If you die your income and fund are lost unless you purchase a joint life annuity.
- You can’t use a tax free lump sum from one pension to fund another (known as recycling).
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