How can a transfer help reduce my tax bills in retirement?

I’m nearing retirement and have a few different pensions squirreled away. I’ve read that a transfer could save me tax in retirement – how can this be true?

Question asked by Steve Harrington
Need Pension Advice?
Call us on 02084327333
First Name
Phone
Email

Answered by Stephen Moore

Staying one step ahead of the tax man

While there’s no difference between the tax liability that attaches to an income drawn from a final salary pension and the income from a defined contribution (money purchase) pension, the far greater flexibility that comes from a defined contribution arrangement means that it presents numerous opportunities for you to reduce your tax liabilities in retirement.

In essence, after you’ve taken any tax-free cash that might be available to you, a final salary pension will pay a guaranteed level of income, that’s likely be index linked, for the remainder of your life.

If the level of that income, or its subsequent indexation, puts you into the 40% tax bracket then you’ll be paying 40% tax throughout your retirement.

By moving to a defined contribution arrangement you can opt to phase your pension pot into what’s now known as pension drawdown. This provides complete control of the way in which you access your benefits allowing you to take either lump sums, or a regular income, or a combination of the two.

This means that you have the option to set your income below your highest marginal rate for income tax and so pay less tax. Meanwhile, a well managed programme of tax-free lump sum withdrawals can be used to increase the total pension benefits you draw each year but without increasing your taxable income.

By moving to a defined contribution arrangement and taking a phased approach to flexi-access drawdown, your pension pot also remains invested and can continue to grow in the tax-efficient environment of your chosen pension ‘wrapper’.

You can even continue to contribute up to £4,000 a year to your drawdown pension (receiving tax relief at your marginal rate) after you’ve begun to take your benefits. It goes without saying that neither of these options is available to those with final salary pensions.

The ‘drawdown drawback’

The other big drawback with final salary benefits is that while they frequently include a reduced (50%) widow’s pension, once you and your spouse have died the value of any remaining pension benefits is lost. This means that they can represent poor value for those who don’t happen to enjoy a long retirement.

By contrast, transferring your final salary benefits to a money purchase arrangement will transform them into a major financial asset that can provide both income and tax-efficient lump sums in retirement with the remaining pension wealth passed to your beneficiaries free of inheritance tax and, assuming you die before age 75 free of any income tax liability.

They can choose to continue drawdown – a process called nominee drawdown –and enjoy the income tax free or they can purchase an annuity, the income from which will also be free of tax. 

Currently, if you die after age 75, your beneficiaries will be liable to income tax at their marginal rate on anything you might leave them. This means they’ll pay tax on any subsequent drawdown or annuity income.

Lifetime opportunities

The rules surrounding your lifetime allowance for pension savings of £1 million are complex and quite different for members of final salary schemes than for those in defined contribution pensions.

However, the greater flexibility of the latter means that there are numerous options for members of defined contribution schemes when it comes to minimising the additional tax liabilities that might attach to their pension pot if it grows past the current £1 million lifetime allowance.

One of the abiding attractions of a pension transfer – whether you have money purchase or final salary arrangements – is the opportunity to bring all your pension savings together into one easy to manage portfolio with one set of reporting. This also makes managing your tax bill far less arduous.

How your income is taxed in retirement

When the times comes, any income you draw from your pension pot will be subject to income tax at your marginal rate, which will be deducted at source by either your employer’s scheme or your drawdown provider. It will be added to the other income you receive each tax year, including the state pension and any earnings from employment, dividends, rental income or your savings. The first part of your income will be covered by that tax year’s personal allowance; after that any subsequent income is taxed at your marginal rate.  

The flexibility to manage your pension income as you see fit means that flexi-access drawdown brings with it the responsibility to monitor your withdrawal levels carefully or risk unintended tax bills or the depletion of your pension pot.

pension transfer advice
 
retirement tax planning
 
pensions and tax
 
flex-access drawdown
 
This information does not constitute financial or other professional advice. You should consult your professional adviser or contact us directly on 02084327333 should you require financial advice. It is important to ensure any insurance policy you take out is suitable for your needs.
Start your journey today...
  Find out how a Drewberry financial adviser can help you reach your destination by making the most of your finances.
Call us on 

Frequently Asked Pensions Advice Questions

 
Do index linked annuities rise with inflation? Are these generally the best annuity...
 
What is an annuity? Is this a popular pension to get in...
 
I’ve been looking into annuities and someone in a forum said to consider a variable annuity, what...
 
I’ve used up my ISA allowance for this year and I’m trying to find other tax-efficient ways...
Need Help? Live chat now and get an instant answer from our Experts...

Neil
Pensions

Victoria
Insurance
Our Latest Reviews
Kevin Paul
05/09/2017

Excellent service renewing our medical insurance, professional advice, good rates found and excellent professional after service, highly recommended.

Max Edgar
09/09/2017

Nadeem was brilliant. He was very patient and worked very well with me to come up with the best solution possible for my budget. Perfect solution. Thank you very much.

Aidan Smyth
11/09/2017

Dealt with me promptly and provided me with the most cost-effective option consistent with my requirements. Very pleased and thank you.

We are rated 4.9/5 based on 1129 independent client reviews.
To read more of our independent client reviews click here →
REVIEWS
EXCELLENT
4.93 / 5 Average
1,222 Reviews
A
Overall Rating
Really, really helpful! Stopped me from signing up with an unhelpful company, and did basically all of the legwork for me in signing up with the right one. I can't have been the most helpful client as I'm 19 and only just started looking into it last week, but he took all the questions in stride! Put up with me turning to ask my dad questions every 2 minutes as well. I was helped by 2 workers; Sam and Nick. Thank you very much to both!
L Finch
Overall Rating
Good communication and follow ups. Friendly. A thorough research for my insurance needs.
M
Overall Rating

Sam Barr-Worsfold was very helpful and provided excellent customer service. Sam discovered I was paying too much premium for my current cover. Sam recommended and helped moved to a new cover with lower premium that provided the level of cover (terms required stated in the provider's policy) I wanted. I recommend highly recommend Sam and Drewberry Insurance. Thank you Sam.
Anonymous
Overall Rating
Thorough, knowledgeable and great communication
Anonymous
Overall Rating
Went through each policy in detail and made sure I was getting the correct one for me