A nice pensions loophole
Small pensions pots have one significant advantage.
Some new figures from Skandia are a useful reminder that small pension pots aren't all bad.
Basically, if your pension savings are sufficiently low, you can withdraw your whole pension pot in one go once you reach the age of 60. If your pot is worth £18,000 or less, you don’t have to buy an annuity and you don’t have to go into income drawdown. Instead you can just take the money and you may not have to pay much tax.
This concession also creates a useful loophole if you’re someone with little or no personal income but who has access to capital for investment. Perhaps you’ve been a non-working spouse based at home for many years.
In this scenario, if you’re approaching retirement, it may make more sense to save via a pension than via an ISA.
Just save a small amount each year for a few years, and you could accumulate pension savings of up to £18,000, and you won’t have to buy an annuity or go into drawdown.
You might be thinking: but if someone isn’t working, how can she pay money into a pension pot. The answer to that is that you can still invest up to £3,600 a year into a pension. The government will pay 20% income tax relief so a person only needs to invest £2,880 for a total contribution of £3,600.
Look at this table from Skandia:
|
Saver age 55 opens a pension |
Paid in by saver |
Paid in by government |
Total paid in |
Cumulative total with 3% growth |
|
Year 1 contribution |
£2500 |
£625 |
£3125 |
£3219 |
|
Year 2 contribution |
£2500 |
£625 |
£3125 |
£6534 |
|
Year 3 contribution |
£2500 |
£625 |
£3125 |
£9949 |
|
Year 4 contribution |
£2500 |
£625 |
£3125 |
£13,466 |
|
Year 5 contribution |
£2500 |
£625 |
£3125 |
£17,088 |
|
Year 6, age 60, pension closes |
|
|
|
|
|
Total paid in by Saver |
£12,500 |
|
|
|
|
Total pension value year 5 |
|
|
|
£17,088 |
The saver has invested £12,500 over five years and ended up with a pot worth £17,088.
The saver could have saved the money in an ISA, but then she would never have had the tax boost paid by the government at the time the money was saved. It’s true that you don’t have to pay tax when you withdraw money from an ISA, but in the scenario outlined above, the saver doesn’t have much income so she probably won’t have to pay much tax on the £18,000 anyway.
And at the very least, she’ll be able to take a quarter of the pension pot as a tax-free lump sum.
So small pensions can be more useful than you might expect!
- · When I talk about a pension pot, I’m talking about money that has been saved for retirement via a defined contribution pension.
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Comments
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I missed the government announcement that the link will be disconnected from the Lifetime Allowance in April when the latter is reduced to to £1.5m. Thanks for the update - my apology to Ed Bowsher on that issue.
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In answer to Luniversal the figure applies to the total of all pots and there is a rule that states that all have to be cashed in at the one time or the only opportunity thereafter is to convert them into an annuity as drawdown will probably be impossible because no-one will want to bother with such a 'piddling' little sum. My wife has two totalling about £7k after she cashed in one with Lloyds for about £4k because it was losing value faster than we were paying in because of charges and no-one warned us about the above rule. Now I guess we shall have to take the 25% and let the government take the rest as she has be diagnosed with Myeloma and has an uncertain future. Don't you just love this pension scam?
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Do these triviality concessions apply to one's total pension pot, or scheme by scheme? Could you accumulate £18,000 in each of several schemes, or redirect one big pot into a number of smaller plans, then wrestle control of the lot out of the hands of the thieves as and when you need lumps of capital?
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21 February 2012