If you’re asking, you’ve probably heard the great news over the past couple of years. Back in April 2015, the UK introduced the biggest shake-up of its pensions rules in almost a century, and allowed UK pension holders to access as much of their pension as they like, as often as they like, from age 55. Fantastic, right?
It’s certainly good. But before you kiss the prospect of an annuity goodbye, break out the champagne and start looking at juicier investment options, it’s worthwhile taking a moment to go over the fine print. Here are a few points to bear in mind when looking into your UK Pension.
You can access 100% of your UK pension fund as a cash lump sum. But only the first 25% are tax-free, with the remaining 75% taxed at your highest marginal rate of tax. Ouch!
And, as always, your specific tax position will depend on the country in which you are living and whether there is a double taxation agreement in place. So if you don’t know the details of your situation, it might be a good idea to talk to your tax advisor!
You can take out those 25% tax-free either as a single lump-sum, or as smaller payments each year adding up to 25%. And you can do that until you are 75 (or until you have what is known as a benefit crystallisation event), and after that, you are taxed at your highest marginal rate. So it may be a good idea to take out those 25% before then. You don’t have to spend it – you can just invest it elsewhere.
The investments you can make with your pension are somewhat restricted. You can buy an annuity, or with a SIPP you can choose from a broader range of asset classes and investment providers. But if you want to invest in a new business venture, or a buy-to-let property, for instance, you’ll have to withdraw those funds. Alternative investments may provide higher returns than those that are available in a UK pension scheme.
So whether it makes sense for you to withdraw the 75% on which you’d have to pay tax depends on three factors – how much tax you would have to pay on it, when you’d have to pay the tax (bear in mind that if you pass away, inheritance tax will also be an issue here for your family), and how the returns on the alternative investments you are looking at compare to the returns of the investments that you could make in the pension scheme. The analysis can be tricky, and it makes sense to talk to a financial advisor about your personal situation. But in short, if your tax rate is not too high, and you have the opportunity to make investments that will provide higher returns for a longer time, such as in real-estate, it may make sense for you to go ahead and withdraw your pension – the higher returns will make up for the tax.
If you live outside the UK, one alternative to withdrawing your pension may be to move it to a Qualified Recognised Overseas Pension Scheme – QROPS. These are overseas pension schemes that HMRC determines are comparable to UK schemes and are regulated. You are allowed to transfer to a QROPS, as long as you are not tax-resident in the UK. The advantage is that QROPS often have broader investment options significantly lower taxes than UK pensions. From the age of 55 you are allowed to withdraw your funds from a QROPS with no tax deducted at source. This retirement age may be earlier than UK pension schemes.
In summary, the pension reform has dramatically increased flexibility, but making the right decision regarding withdrawals in order to maximise your net worth still requires some care. If you need help speak to an independent financial advisor who can go over your specific situation with you.