Utilising Your UnCrystallised Pensions In A Tax Efficient Way

Chris Street

12th May 2017

advice from Optimise Accountants on how property investors can cut income tax liability in 2017

By Louise Misiewicz

Do you want tax relief whilst investing for your future?

Have you planned on how to utilise your pension funds near retirement?

I was speaking to a property investor client this week, and the subject of income tax liability came up – as it often does in these conversations. The start of a new tax year also tends to focus our landlord clients in the UK on how to make income tax savings for the financial year ahead.

The most common question to me and my team of tax specialists get asked by clients is “How do I reduce my income tax liability in the future?”

There are different ways of doing this, of course. For example, the rising personal allowance allows individuals, in certain circumstances, to take extra ‘tax-free cash’ from their personal pension funds.

This is best demonstrated through a recent client example, who I’ll call John.

John, aged 62, has retired on a company benefit pension of £8,000 per year. He’s in good health, owns his home outright and has no plans to move. He needs £11,000 pa (net of tax) to live comfortably and has a personal pension fund of £120,000, which he hasn’t touched yet. Keith has a savings account balance of £4,000, which he wants to keep for emergencies, but needs £15,000 to pay for his daughter’s upcoming wedding. His state pension will commence in 2022.

John plans to take his 25% pension tax-free cash sum of £30,000 to pay for the wedding, and then place the remaining £15,000 into a savings account.

This is five years’ worth of the £3,000 extra income he needs before starting his state pension. Although this meets his main goal of securing extra income, the drawback is that any further withdrawals from his remaining pension will be taken from a ‘crystallised’ fund and will be taxable.

John could take his extra income more tax-efficiently by using his available personal allowance (£11,000 in 2016/17).

This would entail ‘crystallising’ only £60,000 of his pension fund value, releasing a 25% tax-free lump sum of £15,000 for the wedding, leaving £45,000 in a ‘crystallised’ fund. From this fund, John would withdraw a ’taxable’ sum of £3,000 before 5th April this year. The tax payable is nil, because the total income only uses the personal allowance (£8,000 company pension and £3,000 personal pension).

The new pension freedoms allow John to tailor annual taxable withdrawals to the personal allowance, as required. The personal allowance will rise to £11,500 in the next tax year (2017/18) and is set to climb to £12,500 by 2020. Therefore, until his state pension begins in 2022 he may continue to take income (taxed at nil) from his crystallised pension fund.

This is perfect for John’s situation and financial objectives, but he should only withdraw the income he needs to live on each year. Personal pension funds upon death are not included in the value of the individual’s estate for inheritance tax. If he dies prior to his 75th birthday, his beneficiaries may inherit his pension fund without any tax charge.

I would say that pension flexibility is not right for all because investment growth cannot be guaranteed.

John could alternatively utilise a fixed term annuity until state pension age. By crystallising £93,333 from his pension fund, £23,333 would comprise his 25 per cent tax-free cash. The remaining crystallised fund of £70,000 would currently purchase a level income of £3,000 for five years.

A crystallised fund of £59,500 would then be returned to him, with all of his options under the pensions freedom rules available to him. This strategy shifts the investment risk to the fixed-term annuity provider, which may appeal to some individuals in John’s position, despite, in the above example, the inflexibility over the amount of the 25% tax-free cash.

By continuing to accept the investment risk himself, John has far greater flexibility over his income, and may save a significant amount of income tax over the next five years.

This example clearly highlights the importance of getting the right professional inputs as a property investor looking to minimise your income tax liability during 2017 and beyond.

Is it possible to reduce income tax liability in 2017?

I would say the answer is a resounding Yes. But it is best achieved with the right professional advice.

The choice, of course, is up to you. If you’re wondering how to reduce your income tax liability, please feel free to get in touch with me and my team of property tax experts here for an informal chat about it.

The following articles I’ve written below will also provide additional information on income tax savings:

Reducing your income tax liability in 2017

Using property losses to reduce tax liability

Property investment for higher rate tax payers

It’s important to get the right property tax advice at the right time, and my team are geared to provide our property investor clients with the right mix of property investment advice and income tax tips and hints.

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