Many dentists with predominantly private fee income have built up substantial personal pension funds and from April 2015 those over the age of 55 will be able to take whatever cash they want from their pensions, whenever they want it.
Whilst this new flexibility is welcome there are a number of key issues to consider before you turn on the pension income tap.
You pay income tax on withdrawals
Draw more than 25% of your pension and you will pay income tax at your highest marginal rate, on the balance of the withdrawal. For example if you already pay income tax at 40% then your pension withdrawal will also suffer income tax at 40%. Worse still your pension withdrawal could take you into the additional rate tax bracket of 45%, if your total income rises above £150,000 pa. Great care needs to be taken if you earn around £100,000 as you lose £1 of your personal allowance for each £2 of income over £100,000.
Solution: 25% of the total fund can be taken as Tax Free Cash. Beyond this amount only take the income you require.
Beware the change to death benefits
Take a withdrawal from your personal pension and death benefits could be subject to a 55% tax charge. In the event of your death where you haven’t taken any cash or income from your pension, lump sum benefits can usually be passed on to a surviving spouse free of tax*.
Solution: Defer taking cash or withdrawals unless necessary, to avoid changing the basis of death benefits. A 55% tax charge is levied where your spouse takes the value of your pension as a lump sum, therefore they should be aware of the option to take on your pension and withdraw the value as an annuity, or through income drawdown.
Lifetime Allowance trigger
Taking cash or income from any pension triggers an immediate HMRC Lifetime Allowance test. If you have previously taken NHS Pension benefits you will have already used a proportion of your Lifetime Allowance. Taking income or cash from personal pensions could cause you to breach the allowance and suffer an additional income tax charge of 25% or a charge on cash withdrawals of 55%. Lifetime Allowance issues have been made worse by the recent reduction to £1.25m and should be considered in some detail. Those with over £1.25m worth of pension assets can consider applying for HMRC’s Individual Protection before April 2017.
Loss of investment growth
Unless you plan to spend it, taking money out of your personal pension can be bad for your financial health. Inflation continues to beat net returns on cash deposits and with interest rates set to remain low, this may continue for some time. Pension fund investments grow largely free of tax, so avoiding needless withdrawals makes sense.
Those dentists considering taking a withdrawal from their personal pensions should consider the implications for inheritance tax (IHT). In most circumstances death benefits paid from a registered pension scheme are usually free of any liability to IHT. Leaving your pension intact could therefore reduce your overall liability to IHT.
If you intend to take income or cash from your pension you may well leave a substantial amount invested within your pension. This is likely to be the case if you don’t require additional income perhaps due to ongoing income from dentistry or alternative sources such as your NHS pension. With no requirement to purchase an annuity your pension funds could remain invested for the medium to long-term. In this case a regular review of investment risk and the quality of the funds in which you invest, is advisable. Independent financial advice with an annual review of your income requirements will ensure that your pension continues to meet your objectives and to make sure you are aware of legislative changes. .
*this is subject to HMRC Lifetime Allowance rules