Are you drawing an income from your pension and found you now have multiple pension pots?
If you have a personal pension and have made use of the flexible drawdown features launched on ‘Pension Freedoms Day’ in April 2015 you may find that your pension has been split into multiple pension pots.
There is actually quite a simple reason for this and if used correctly, it allows you to minimise the Income Tax you pay in retirement.
Multiple pension pots for flexible access
There are 6 ways of taking money out of your pension under rules announced as part of ‘Pension Freedoms’.
Not every pension provider will offer all 6 methods so this is something to check because you may be missing out on a method that suits your circumstances much better.
The 6 ways to take money out of your personal pension flexibly are:
1. Leave your pension untouched. If you don’t need the money you can leave your pension invested for as long as you like even if you are retired. This can be a great way to save Inheritance Tax on your death.
2. Purchase an annuity. This means selling your pension to an insurance company which will secure you an income for the rest of your life.
3. Flexi-access drawdown. Take money out of your pension as and when you need it. Some withdrawals could be taxable, some could be tax free depending on how much you take.
4. Taking money out in chunks. It’s technical term is UFPLS (Uncrystallised Funds Pension Lump Sum) and basically means every withdrawal is 75% taxable and 25% tax free.
5. Taking the whole pot out in one go. Ending the pension.
6. A mix on any of the above options. You can combine different options at different times to suit your lifestyle.
It’s option 3 above that will usually mean you end up with multiple pension pots.
This happens because when you make a withdrawal from your pension some of it may be taxable and some tax free.
If you have pension funds that have never been touched before (known as uncrystallised) then you will be entitled to take up to 25% of the untouched pot tax free (known as the pension commencement lump sum).
The remaining 75% is subject to Income Tax at your marginal rate.
Using flexi-access withdrawals means you could just take out bits of your tax free cash element and leave the bit subject to tax inside your pension for another day.
If you follow this method, the pension provider must carve out some of your pension to provide your tax free cash lump sum. The tax free lump sum has to be 25% of the carve out so if you don’t take the other 75% out this will be placed in a separate ‘taxable’ pot. This is why you end up with multiple pension pots.
Let’s look at an example…..
Sarah has a £400,000 personal pension. She has never withdrawn from this pension before but she is over 55 and wants to top up her monthly income by £1,000 per month.
She is still working and already a higher rate tax payer so doesn’t want to pay 40% Income Tax on any of her pension withdrawals.
Using flexi-access drawdown Sarah can carve out a monthly amount £4,000 from her pension pot. 25% of this (the tax free lump sum) will be withdrawn and give her the £1,000 she needs. The remaining £3,000 will stay in the pension but go into a different pension pot so Sarah knows that in the future any withdrawals from this pot will be subject to Income Tax.
Sarah could keep doing this until she had carved out her entire pension pot at which point she would only be left with her ‘taxable’ pot.
It’s important to remember that the new ‘taxable’ pot can still be invested the same way as your other pension pot and will continue to grow tax free.
Other uses for multiple pension pots
Rather than just using multiple pension pots for making withdrawals on a flexible basis to suit your needs you can also use them for different investment strategies.
Again this will depend on your pension provider but ultimately you could move part of your funds so they are ring-fenced for the short term and therefore with a lower level of investment risk. Then some funds ring-fenced for the longer term where you take a high level of investment risk.
Some people even use one pot that is 100% in cash so this covers the next few years of withdrawals and then they don’t have to worry about what the stock market does.
I’ve seen some clients who ring-fence some of the pension funds as a future inheritance and because they still have 20+ years left to live, they take very high investment risk to increase the pot size left to their children which will ultimately be Inheritance Tax free.
Using multiple pension pots can be great when it comes to your retirement planning you just need:
- The right pension
- The right investment strategy
- The right plan
We are able to help with all three of the above so if you would like to chat through your options, understand where you stand and what you need to do next just book in for a no cost, no obligation call.
Risk warning:
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.
