The fragile economic climate and the imminent increase in the minimum pension age at which clients can start to draw benefits from their pensions has created an environment where people may have accessed their pension fund earlier than anticipated.
Some clients may have accessed their pension fund early and taken a tax-free pension commencement lump sum in order to repay existing debts during the credit crunch such as an outstanding mortgage.
Many of these individuals will continue to work and may not require an income from their pension fund in the short term.
While it is undoubtedly a sensible approach to reduce income taken from a pension fund while the income is not
needed, there are several financial planning opportunities that exist around using the income that is available.
These opportunities, if used correctly, will provide greater long-term tax-efficiency towards an investor’s retirement plans.
Advisers will be familiar with the HMRC rules that restrict the tax-efficiency of recycling a pension commencement lump sum back into the pension in an attempt to boost the eventual value of a pension pot.
The recycling rules do not apply to the income that is available from the pension after a PCLS has been taken, provided that the increased contribution rule is not breached.
For example, within certain limits, income drawn from a pension can be recycled back into the same pension as a new contribution, boosting the future tax-efficiency of a client’s fund.
For some investors, it may be appropriate to access the pension fund and take an initial lump of tax-free cash without needing to take any ongoing income through the use of income drawdown.
By not taking an income, the client will continue to have a degree of investment control and future income flexibility.
However, as an alternative, any excess income (up to the full income entitlement) could be drawn out of the pension fund and then placed back into the fund as a new contribution. Tax relief (equal to the income tax paid on the income payment received) may be available on the contribution.
This provides a neutral income tax position for the investor. But by doing this, the client will increase the tax-efficiency of their retirement fund
through the potential for taking further PCLS in the new future.
By making new contributions, the client would create a new uncrystallised fund. From this, a further PCLS of 25 per cent of that fund (within the lifetime allowance) would be available.
If the client dies before they access this second pot of money, the fund built up from the new contributions will not be subject to the 35 per cent tax charge that would otherwise have applied had it been left inside the income withdrawal component.
If a client’s pension scheme allows for additional designation, recycling income will enable the client to increase the maximum annual income available from the existing incomewithdrawal fund in the future
Relievable contributions for clients who have fully retired would be at a maximum of £3,600 a year. However, for clients who continue to work, the recycled contributions could be far higher and may, using the maximum income available from the income drawdown fund, still be less than the 100 per cent of the client’s relevant earnings in a tax year.
If a client’s pension scheme allows for additional designation, recycling income will enable the client to increase the maximum annual income available from the existing income-withdrawal fund in the future.
Together with increasing gilt yield values and recovering markets, this form of recycling will potentially contribute to a significant increase in the annual income available to an investor from an income withdrawal fund over its five-year review period.
However, recycling income cannot be used in conjunction with any pre- A-Day income-withdrawal facility. Increasing the existing maximum
annual income can create a higher income entitlement, allowing a bigger amount of money to be recycled into the fund.
Clients wishing to take advantage of income recycling must act fast and take action before tax year end and this year’s allowance is lost. With the last working day of this tax year being April 1, 2010, clients will need to ensure that instructions are received by the provider in good time to allow any added income withdrawals to be paid before the end of March.
Advisers should review the longterm benefits of recycling income to build a client’s retirement fund. There are significant financial planning
advantages highlighted in this article that are available to relevant clients. Advisers should consider these options as a natural part of reviewing a client’s post-retirement pension arrangements.
Before embarking upon such a course of action, the adviser would be recommended to check for those with higher incomes that have already
benefited from pension inputs in the tax year to ensure that the recycled income will not incur a special annual allowance charge.