Pension planning in 2015/16

Transcription

1 ADVISER FACTSHEET Tech Talk April 2015 Pension planning in 2015/16 The announcements of greater flexibility with pension withdrawal and the introduction of the zero rate for the first 5,000 of savings income provide some excellent tax planning opportunities. This Tech Talk considers: How to make maximum use of the increased flexibility in pension drawdown from 2015/16 onwards; How to preserve the zero rate for savings; How pension contributions can be made to allow a transfer of the personal allowance between spouses and civil partners; Worked examples. Contents Pension income following the new rules The zero savings rate for the first 5,000 of taxable savings income over the personal allowance Transferrable personal allowance Comments For professional advisers only

2 Introduction Since 6 April 2015, many members who have reached retirement age have the freedom to access all pension funds regardless of secured income levels elsewhere. Since 6 April 2015, the starting savings rate has been 0% on the first 5,000 of income over the personal allowance. For pensioners with small amounts of other income which do not exceed 15,600, this could be extremely beneficial. This Tech Talk will look at the tax implications of these changes and the interaction of the new rules, particularly: Pension income and income tax under the new rules; Pension drawdown and the interaction with the new starting rate for savings; The transferable part of the personal allowance between spouses/civil partners. Pension income following the new rules From 2015/16 onwards, flexi-access drawdown will be available to most pension savers who have reached retirement age, regardless of the size of their total pensions savings and other guaranteed income. Any pension funds withdrawn by the original member and which exceed any PCLS available will be taxed at the individual s marginal rate of income tax. There has been a substantial amount of commentary in the press speculating on whether this will result in a mass withdrawal of pension savings. Whether this will happen in practice remains to be seen, as the tax implications may make this unattractive. The taxation of each additional 1 of income withdrawn at the marginal rate of tax means that for higher and additional rate taxpayers, achieving a further 1 of net income can prove extremely expensive. The table below summarises the total withdrawal which must be made to achieve the further 1 of income from crystallised funds with no PCLS remaining in the 2015/16 tax year or income taken from an uncrystallised funds pension lump sum once the 25% tax-free cash has been taken. Marginal rate of tax Grossed up withdrawal Net income Income tax paid Basic rate band 20% p 0-31,785 Income bands (after personal allowance of 10,600) Higher rate band 40% p 31, ,000 Higher rate band 60%* , ,200 Higher rate band 40% p 121, ,000 Additional rate band 45% p 150,001 + * The effective rate of tax is 60% for income between 100,000 and 121,200 due to the tapered withdrawal of the personal allowance. 2

3 The additional tax cost may mean that, in reality, funds are not withdrawn from pensions in the rush expected. According to the Office of Budget Responsibility, however, six out of seven taxpayers in receipt of pension income, many of whom received relief on pension contributions at higher rate, will be basic rate taxpayers in retirement. This means that, for the vast majority of people relying on their pension income in their retirement, there may be opportunities available to preserve the 0% savings rate on the first 5,000 of income, as well as transferring 1,060 of the personal allowance. The zero savings rate for the first 5,000 of taxable savings income over the personal allowance Income is taxed in a strict order: Earned income, including pension income; Savings income; and Dividend income. The personal allowance will be used first by earned income, including pension income, before savings income and then dividend income. This means that, where someone receives a relatively modest amount of income from pensions which, combined with their savings income, does not exceed 15,600, they will be able to make use of the zero savings rate. However, each additional 1 of income withdrawn from a pension which eats into the zero savings rate suffers an effective rate of tax of 40%. EXAMPLE In 2015/16, Henry has pension income of 10,600 and gross savings income of 5,000. Income source Annuity income 10,600 Covered by personal allowance 0 Savings income 5,000 Covered by zero savings rate 0 His income tax liability is nil. What happens if Henry s pension income is 11,600? Income source Annuity income 11,600 10,600 covered by personal allowance 1,000 taxed at 20% 200 Savings income 5,000 4,000 covered by zero savings rate 1,000 taxed at 20% 200 Henry s income has increased by 1,000, but his income tax liability has increased from nil to 400, representing an effective tax rate of 40%. 3

4 This means that, for savers with low earned income but significant investment income, from 2015/16 onwards care should be taken to plan drawdown from pensions to ensure that the benefit of the zero savings rate is preserved if possible. Once drawdown income exceeds 15,600, the zero savings rate will be lost entirely. However, with some income planning, it might be possible to preserve the zero savings rate. For the purposes of the case study, we will assume that: The personal allowance remains unchanged from 2015/16 onwards; and The tax rates and bands remain unchanged from 2015/16 onwards. CASE STUDY Charlene retired at the end of 2014/15. In 2015/16, she will receive the following income: annuity income of 12,100 gross bank interest of 6,000 a small portfolio of investments which generates 900 of net dividend income each year a crystallised pension pot of 150,000. Charlene will need net income of 21,600 per annum to enjoy her retirement. Before accessing her pension fund, Charlene s income tax position is as follows: Annuity income 12,100 10,600 (personal allowance) 20% 300 Bank interest 6,000 0% (zero savings rate) 20% 500 Dividend income 1,000 10% 100 Total 19, Charlene s total net income is 18,200. If Charlene withdraws a further 5,125 of gross income from her pension, her income tax position will be as follows: Annuity income 12,100 10,600 (personal allowance) 20% 300 Drawdown income 5,125 20% 1,025 Bank interest 6,000 20% 1,200 Dividend income 1,000 10% 100 Total 24,225 2,625 4

5 CASE STUDY continued Charlene s net income is 21,600 and her effective rate of tax is 10.9%. Over three years, assuming that Charlene s income remains static and she does not need significantly more income than expected, Charlene will need to withdraw 15,375 from her pension in total over the tax years 2015/16, 2016/17 and 2017/18 to achieve her required net income of 21,600 in each year. But what happens if Charlene withdraws 13,625 of income from her pension in 2015/16? In 2015/16, her income tax liability will be: Annuity income 12,100 10,600 (personal allowance) 20% 300 Drawdown income 13,625 20% 2,725 Bank interest 6,000 20% 1,200 Dividend income 1,000 10% 100 Total 32,725 4,325 Charlene can put the 6,800 of excess net income from 2015/16 in an ISA and withdraw the funds as needed in 2016/17 and 2017/18 to maintain her standard of living for those years. In 2016/17 and 2017/18, she takes no further funds from her pension and her income tax liability will once again be 900 in each year as previously calculated. 2016/17 Income source Income Tax Annuity income 12,100 10,600 (personal allowance) % Bank interest 6,000 0% (zero savings rate) % Dividend income 1,000 10% 100 Total 19, An ISA withdrawal of 3,400 is taken from the additional income withdrawn in 2015/16 to supplement Charlene s income in 2016/17. The same analysis applies to 2017/18. Charlene s income tax position for the three years is therefore as follows: Tax year Total gross income Total income tax Total net income 2015/16 32,725 4,325 28, /17 19, , /18 19, ,200 Total 70,925 6,125 64,800 Over three years, her income tax liability has fallen from 7,875 to 6,125 and the effective tax rate has fallen from 10.9% to 8.7%. Her total net income over the three years remains static at 21,600 per annum, but her overall income tax liability has fallen by 1,750 and 1,750 less has therefore been withdrawn from her pension. At the time of writing this Tech Talk, details of the 1,000 exempt bank interest band have not been published. If Charlene can take advantage of this, her income tax liability in each year will decrease by a further 200 in each of 2016/17 and 2017/18. It should also be borne in mind that the zero savings rate may be withdrawn, meaning that the planning will no longer be tax effective. 5

6 Transferable personal allowance From 2015/16 onwards, it will be possible for spouses and civil partners to transfer 10% of their personal allowance, provided that each is a basic rate taxpayer. Where the personal allowance is being transferred from a spouse or civil partner who does not have sufficient income to use their personal allowance in full, this is worth 212. However, where one spouse or civil partner is in receipt of significant investment income and can take advantage of the zero savings rate, this can be worth 424. EXAMPLE Madge is retired. She is a member of a defined benefit scheme and receives a generous annuity income of 40,100 during 2015/16. Her income tax liability is 5,900. Income Annuity income 40,100 10,600 (personal allowance) 0 20% 5,900 Total income tax 5,900 Her husband, Harold, has more modest pension savings. His annuity income is 11,660 and he has savings income of 6,000. Harold s income tax liability is: Annuity income 11,660 10,600 (personal allowance) 20% 212 Bank interest 6,000 0% (zero savings rate) 20% 412 Total 17, If Madge transfers 1,060 of her personal allowance to Harold, her tax liability increases to 6,112. Income Annuity income 40,100 9,540 (personal allowance) 0 20% 6,112 Total income tax 6,112 Harold s tax liability decreases as follows: Annuity income 11,660 10,600 (personal allowance) 1,060 (transferred personal allowance) Bank interest 6,000 0% (zero savings rate) 0 20% 200 Total 17, As we saw with Henry above, the effective rate of tax for each additional 1 of earnings is 40% on savings income over the starting rate for savings. Madge transferring 1,060 of her personal allowance to her husband means that he has saved 424 in tax at an additional cost to her of

7 A spouse or civil partner can elect to transfer 10% of their personal allowance to their spouse or civil partner provided neither suffers tax at a rate other than the basic rate, dividend ordinary rate or the starting rate for savings. This means that net pension contributions could be used to ensure that a spouse or civil partner is not a higher rate tax payer, which will allow them to transfer 10% of their personal allowance to their spouse or civil partner. CASE STUDY Jim has recently retired. He was a partner in a professional firm before his retirement, and received a substantial cash payment of 300,000 when he was bought out by the remaining partners. His pension annuity income is 11,660 per annum and he will receive 5,000 of gross bank interest during 2015/16. He is married to Beverley, who earns 45,385 per annum. Their income tax liabilities are currently: Jim: Annuity income 11,660 10,600 (personal allowance) 0 20% 212 Bank interest 5,000 0% (zero savings rate) 0 20% 212 Total 16, Beverley: Earned income 45,385 10,600 (personal allowance) 0 20% (basic rate band) 6,357 40% (higher rate band) 1,200 Total 7,557 What happens if Beverley makes a net pension contribution of 3,248 (which equals a gross pension contribution of 4,060)? All of her income will fall within the basic rate band and she will now be eligible to transfer 1,060 of her personal allowance to Jim. Her income tax calculation becomes: Earned income 45,385 9,540 (personal allowance) 0 20% (basic rate band) 6,357 20% (extension of basic 812 rate band) Total 7,169 Jim s income tax position will become: Annuity income 11,660 10,600 (personal allowance) 0 1,060 (transferred personal allowance) 0 Bank interest 5,000 0% (covered by zero savings rate) 0 Total 16,660 0 As a result of Beverley s net pension contribution of 3,248, Jim and Beverley s combined income tax liability has fallen from 7,981 to 7,169 (a total saving of 812). The total tax benefit between them is 1,624 ( 812 income tax saving and the 20% tax credit reclaimed within Beverley s pension). The overall net cost to Jim and Beverley is 1,624 ( 3,248 less the 1,624 of income tax relief). 7

8 Comment Pensions in the 2015/16 tax year have become extremely attractive savings vehicles. Aside from the obvious attractiveness of increased flexibility of withdrawals once retirement age has been reached, the possibility of making a pension contribution to allow a higher rate taxpayer to transfer 10% of their personal allowance to their spouse or civil partner can be highly lucrative. The increased flexibility in pension withdrawals also offers scope for those with significant savings and investment income to plan ahead and take advantage of the zero savings rate which will be on offer from 2015/16 onwards. For these reasons, it will be extremely beneficial for those in retirement and those whose income is just over the higher rate threshold to plan ahead to try to preserve extremely generous tax rates as far as possible. Further information Joanna Fergusson Technical Manager Tax and Trusts Visit the Technical Hub for further information: Please note that every care has been taken to ensure that the information provided in this article is correct and in accordance with our understanding of current law and HM Revenue & Customs practice. You should note however, that James Hay Partnership cannot take upon itself the role of an individual taxation adviser and independent confirmation should be obtained before acting or refraining from acting upon the information given. The law and HM Revenue & Customs practice are subject to change. The tax treatment depends on the individual circumstances of each client. James Hay Partnership is the trading name of James Hay Insurance Company Limited (JHIC) (registered in Jersey number 77318); IPS Pensions Limited (IPS) (registered in England number ); James Hay Administration Company Limited (JHAC) (registered in England number ); James Hay Pension Trustees Limited (JHPT) (registered in England number ); James Hay Wrap Managers Limited (JHWM) (registered in England number ); James Hay Wrap Nominee Company Limited (JHWNC) (registered in England number ); PAL Trustees Limited (PAL) (registered in England number ); Santhouse Pensioneer Trustee Company Limited (SPTCL) (registered in England number ); Sarum Trustees Limited (SarumTL) (registered in England number ); Sealgrove Trustees Limited (STL) (registered in England number ); The IPS Partnership Plc (IPS Plc) (registered in England number ); Union Pension Trustees Limited (UPT) (registered in England number ) and Union Pensions Trustees (London) Limited (UPTL) (registered in England number ). JHIC has its registered office at 3rd Floor, 37 Esplanade, St Helier, Jersey, JE2 3QA. IPS, JHAC, JHPT, JHWM, JHWNC, SPTCL, SarumTL and IPS Plc have their registered office at Trinity House, Buckingway Business Park, Anderson Road, Swavesey, Cambs CB24 4UQ. PAL, STL, UPT and UPTL have their registered office at Dunn s House, St Paul s Road, Salisbury, SP2 7BF. JHIC is regulated by the Jersey Financial Services Commission and JHAC, JHWM, IPS and IPS Plc are authorised and regulated by the Financial Conduct Authority. The provision of Small Self Administered Schemes (SSAS) and trustee and/or administration services for SSAS are not regulated by the FCA. Therefore, IPS and IPS Plc are not regulated by the FCA in relation to these schemes or services.(01/14) JHSTT 01 APR15 LD