How to overcome the emergency tax problem with ad hoc withdrawals
Pension flexibility statistics
£158,596,127 – that is the amount of overpaid income tax that HMRC have returned when people have flexibly accessed their pension since 1 January 2017.*
*Source: HMRC Pension Schemes Newsletters 86, 89, 92, 95, 98 and 101.
When someone flexibly accesses their pension and makes an ad hoc withdrawal, there is little understanding of the tax implications of this decision. People do not realise that this ad hoc withdrawal will only be assessed at the time of payment as if they have one twelfth of their personal allowance and one twelfth of each tax band. This can result in the overpayment of income tax and the need to claim this amount back.
For example, if someone makes an ad hoc withdrawal of more than £12,500 in the 2018/19 tax-year, they will be paying 45% income tax on the withdrawal value above that amount. If that person is a basic rate or higher rate taxpayer for the tax year, they will need to claim the excess income tax.
In that context - Six out of seven people who are higher rate income tax payers when they are contributing to a pension are basic rate income tax payers when they withdraw their benefits in retirement.*
*Source: Institute of Fiscal Studies.
The process can therefore:
- be complicated,
- cause delay in the correct amount of tax being deducted, and
- result in more money than necessary being withdrawn from the pension.
Making an ad hoc withdrawal from a flexi-access drawdown arrangement is a trigger event for the Money Purchase Annual Allowance.
The small pots feature of the Collective Retirement Account can help
The Collective Retirement Account can provide a small pots option at any time on or after someone’s 55th birthday. This option is available regardless of the value of someone’s account.
When a small pots payment is made from uncrystallised savings, 25% of the payment is tax-free with the balance subject to basic rate income tax. Any higher or additional rate income tax due is collected via the client’s self-assessment return. Therefore, when a small pots payment is made, the taxable income is not assessed for income in the same way as an ad hoc withdrawal. For a basic rate taxpayer, the net payment they receive will be what they expect.
For the 6 out of 7 people (referred to above) this process is:
- prompt, and
Making a small pots withdrawal from uncrystallised savings is not a trigger event for the Money Purchase Annual Allowance.
The small pots feature is where up to three small pots can be created out of someone’s single big pot. These small pots can be taken together or separately over time. Each small pot is £10,000 of uncrystallised pension saving.
Small pots will not work for clients who
- are younger than 55
- have registered for Enhanced Protection, Fixed Protection 2012, 2014 and 2016
- are going to apply and rely on Fixed Protection 2016 in future
- are entitled to protected tax-free cash - small pots cash limited to 25%
- want to crystallise monies greater than £10,000 per pot
- have no unused LTA available
- have previously created three small pots. Also, need to be sure that do not intend to exercise a small pots option in the future.
Access pension money, make contributions and maintain PCLS growth potential using Small pots
Need more information? Please contact your consultant or call us on 0808 171 2626 (between 8.00am and 7.00pm Monday – Friday).