Benefit of the doubt

9 February 2012

I am 65 and have just retired from employment. I am now taking the benefits of my final-salary pension. During this tax year, I also have self-employed earnings of £50,000, which I do not need at present. Do I have any options in terms of making a pension contribution with this money?

As the £50,000 has not been taxed at source, it is your responsibility to complete a tax return and pay the tax due. As this £50,000 takes your total taxable income over £100,000, you will lose your personal income tax allowance. The tax due on this sum will be £22,990, giving you £27,010 in your hand.

As you do not need this income at present, you could make a pension contribution of £50,000 gross. This effec-tively reduces your self-employed earnings to zero, the tax due and tax relief are offset. The actual mechanics are a little more complex but I am just focusing on the final effect at present.

It will also be necessary to check this contribution is allowable but, again, I will not go into detail.

In brief, the two options are to have £27,010 in your hand or £50,000 in a pension policy.

Once this money is held in a pension, it must adhere to pension rules. As such, this means there are restrictions on the amount and way in which money is taken out. You can take up to 25 per cent of the fund as a tax-free lump sum at any time. The rest of the fund must be used to provide an income, which is taxable.

As you are in receipt of a final-salary pension in excess of £20,000 a year, you meet the requirements to use flexible drawdown, meaning you can take as much income as you like, whenever you like, directly from your fund but you cannot start this until the following tax year.

Looking at your £50,000 pension fund, you could take £12,500 as tax-free cash and the remaining £32,500 as income when you wish, the best way being to maximise your income tax position each tax year. Worst-case scenario, if all this income ends up being taxed at 40 per cent, you would end up with £37,500 x 60 per cent = £22,500 in your hand. When the tax-free cash is added back, the total amount using this route becomes £35,000, which is £7,990 more than the direct payment route.

Using the pension route, including taking the benefits by flexible drawdown, could be considerably more tax-efficient for you. As well as the income tax saving, it is worth noting that while in the pension policy, your money will grow tax-efficiently.

There are other factors to consider, such as costs and risks. There is always a risk of some sort, whether it is investment risk or risk of rule changes, which may affect the final outcome.

As always, individual prof-essional advice is essential before any action is taken.

Emma Duncan is director of Thameside Wealth Management

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