Tax is complicated and too many retirement savers take money from their pensions without considering the financial consequences.
You can end up with more tax-free cash than the 25% lump sum simply by applying tax rules in the correct way.
It’s not avoidance or evasion, but your right to arrange your finances in the way you pay the least tax.
A study by charity Citizens Advice shows a third of over 55s simply draw their tax-free lump sum as soon as they can and put the money in the bank regardless of if they intend to spend it or not.
Leaving unspent tax-free cash in the pension offers more benefits.
Tax saving pension strategy
The money is exempt from inheritance tax, which would be due if the money was taken out and left in the bank and because the cash remains invested, the fund is still growing.
This also means the tax-free lump sum is growing as a quarter of any extra fund growth is also tax-free.
Take a 60-year-old due to retire at 66 years old who has a £200,000 pension pot and wants to give up work now. Phasing in retirement and an awareness of how tax affects income as you age is really important as tax strategies show.
Most people would say they have a 25% tax-free lump sum and then split the remaining pot over several years.
That’s a perfectly good strategy, but how about realising that at 60 you have no other taxable income and instead of taking the tax-free lump sum, withdraw £11,500?
Using your tax-free allowances
Why? Because the £11,500 uses up your annual personal income tax free allowance, so no tax is paid on the money.
Then top the cash up from your pension tax-free lump sum – you do not have to take the full amount, just as much as you need, say £10,000.
The move sees you withdrawing £21,500 from you pension and paying no income tax.
Continue with the strategy over the next few years and a £200,000 fund will be drained by around half. Then the state pension kicks in. If the pension rises at 2.5% a year for six years. It’ll be worth just shy of £9,500 a year.
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