It may sound far fetched but it is a trick (although I hate using that term) which can boost the amount you can take from your pension tax free. Let me explain........
But before I do there are a few points which you must take on board first:
- generally you must be aged 55 to start withdrawing pension benefits
- people under 75 can contribute to a pension even if they do not have any earnings (up to a maximum of £3,600 gross)
- If you are drawing pension benefits via pension drawdown (even if you are not taking any income and just released your tax free cash entitlement) in the event of your death the pension fund will be subject to a death tax of 55%.
- A pension fund from which you have not commenced withdrawing benefits is exempt from the 55% death tax when passed on to beneficiaries in the event of your death before age 75.
Now imagine if a person, over age 55, who does not need the retirement income which their pension fund can produce takes their 25% tax free cash lump sum entitlement and places the remaining pension fund into drawdown. Their remaining pension pot (after taking the tax free cash lump sum from which they are not withdrawing income at the moment) will be subject to a 55% tax charge on their death.
The recycle trick
If they are under 75 rather than simply leave their pension pot to grow (without taking income) they could instead withdraw some income and place it into a NEW pension scheme and get tax relief on the contribution, which will effectively offset the tax paid when drawing the income from the existing pension pot. For someone who is not working they can contribute a total of £3,600 a year into a pension (£2,880 net of basic rate tax).
If the person is working, they can contribute even more the maximum of £50,000 a year or their total earnings, whichever is lower.
The net result is that their pension pot continues to grow but they take some of their existing drawdown pot (i.e. take some income) and put it into a new pension plan which they don't take benefits from. If they kept doing this over an extended number of years the result would be
- they will have two pension pots (one in drawdown) and one which is not. The latter will be exempt from the death tax charge when they die and they can pass the fund to their beneficiaries tax free.
- plus the new pension pot will have a separate new tax free cash entitlement of 25%.
How much tax can you save?
Skandia, an investment firm recently calculated that a person with £150,000 pension entering income drawdown at age 55 and recycling unused income for 10 years could save £28,000 in tax.
- The pension trick that could get you a second tax-free lump sum of £13k and save your family £28k if you die
- Recycling unused pensions can cut £28,000 in tax
But as ever if you are interested in the idea seek financial adviser from an independent financial adviser who specialises in pension advice.