These new rules, along with the potential returns, mean that many are now considering investing their pension pot in buy-to-let rental property. In fact, recent research conducted by Ipsos Mori estimates that 16% of people cashing in their funds intend to invest their savings in buy-to-let.
The big issue with taking out your pension all in one go, which some may not be taking into account, is the amount of tax you will have to pay immediately. In this article, Oscar Wingham looks at what tax you will have to pay on large pension withdrawals and the inheritance tax implications of investing in property.
Tax rates on large pension withdrawals
HMRC will treat withdrawals as regular income, meaning some basic rate taxpayers could face tax rates of up to 45% if their lump sum reaches above the £150,000 additional rate limit when added to their other income.
Example: Withdrawing £100,000 at once after 6 April 2015
- The first quarter (£25,000) will be tax-free, leaving £75,000
- We assume you have no other income other than a state pension of £5,500
- Therefore you have £5,100 of tax free earnings (£10,600 – £5,500)
- Or £69,900 taxable earnings (£75,000 – £5,100)
- Of this, the first £31,785 will be taxed at the 20% basic rate, leaving you with £25,428.
- The remaining will be taxed at the 40% higher rate, leaving £22,869
- So, you would be left with £78,397 (£25,000 + £5,100 + £25,428 + £22,869)
You should note, that you will pay tax on proportionally more of your private pension if you have a higher state pension than £5,500.
How does this compare to previous pension rules?
Previously, very few scheme administrators would have allowed unauthorised payments in this way and if they did, the unauthorised payment charge would almost certainly have included a scheme sanction charge raising the penalty to at least 70%, if not 83%. Therefore, even if possible with your scheme administrator, the amount you would be left with would be significantly lower than it will be post 6 April 2015.
What other options do I have?
One of the options will be to split your withdrawals. From 06 April 2015 you are also be able to access your pot each year, and most people will be able to take 25 per cent tax-free. Therefore, you could split your withdrawal across consecutive years if it helps you to avoid being pushed into a higher band of tax.
You could also choose to take all of the tax free cash as income over a number of years (perhaps whilst you are still working), or indeed potentially any combination of taxable and tax-free elements. Certainly, spreading the taxable pension ‘income’ withdrawn over several years would make sense depending on the size on the fund.
In some cases money can be withdrawn from pensions in a manner that does not trigger an income tax charge at all and protects the value against inheritance tax – so you should always obtain proper advice on this before you cash in your pension funds.
Inheritance tax: How does passing on a property differ from a pension pot?
Pensions can now be passed on tax-free in some instances, or in others tax will only be paid at income tax levels by the beneficiary on money if they withdraw it.
But, if you invest in property then from an inheritance tax perspective you will revert to the standard level of inheritance tax on property. If the individual’s estate exceeds £325,000 (or up to £650,000 for married couples or civil partners), inheritance tax is charged at 40% on everything above this threshold. Therefore, this creates a challenge for those moving their pension funds from a pension to property.
There are various ways to reduce exposure to inheritance tax and our tax advisors can discuss your circumstances and the options available if you choose to invest in property. This advice should be sought before making the property purchase so that it can be structured appropriately.
Should I stick with my pension?
One additional point to bear in mind is that growth on pension investments are free of capital gains tax and largely free of all income tax. Whereas in comparison, whilst buy to let income and capital growth can be minimised, it takes more thought and specialist planning therefore you should seek support from tax advisors specialising in buy to let.
Tax advisors
At Rouse Partners our west of London based team offer a range of compliance and advisory services for those with property investments.
Contact our tax team for a quotation and to discuss how we can assist you.
We also have a close relationship with a specialist pension’s advisor who we can introduce you to, should you require advice in this area.
Oscar heads our tax department and provides advice on tax structuring, planning and compliance services to entrepreneurs and their businesses.