With the threat of further restrictions looming and the end of the job retention scheme at the end of October (with the replacement support scheme only available to “viable” jobs), more over 55s may be pushed towards accessing their pension at an earlier stage than planned.
Good advice can be even more valuable in difficult times when the impact of bad decisions could be exacerbated. This doesn’t just apply to the decision as to whether to access funds or not, but also the way pensions are accessed – if that is the decision that is taken.
For those who hadn’t planned retirement just yet, they may require funds to tide them over while they seek alternative employment. Of course, with the current state of economic play, there is no real knowing how long that could be for.
The most obvious option would be to just take the tax-free element, whether as a lump sum to last several months, or in instalments with regular benefit crystallisations. This has the advantage of not only being tax free, but also not triggering the money purchase annual allowance (MPAA) which would restrict the opportunity to rebuild the fund if the client is in a position to pay in contributions at some point in the future. This is an important consideration, especially for those further from their planned retirement date.
The downside of taking just PCLS is that you have to crystallise more of the fund, so the client will have a smaller tax-free element at a future date when they get to the planned retirement date.
As an alternative, taking a UFPLS payment has the advantage that you crystallise a much smaller portion of the fund – so preserving a larger element for future PCLS. How much this is worth will depend to a certain extent on how markets perform between now and accessing PCLS, and importantly what tax band the individual falls into when they later access their pension.
The downsides are that the MPAA is triggered, and most of the payment is taxed. However, for those nearer their planned retirement, or who are unlikely to have more than £4,000 a year to pay into their pension, the lower annual allowance will be less of a concern.
Another important point to consider is the frequency of payments, specifically those that are taxable.
If regular payments are being taken, then although there may be a level of over-taxation in the first month, a new tax code is then issued and, generally speaking, the situation is put right in the remaining regular payments in the tax year.
However, when a one-off payment is taken, it can be massively overtaxed.
For example, to receive a net payment of c£25,000 into the client’s bank account they would have to take a UFPLS payment of £35,000. This may sound steep – it is – but if a client takes a UFPLS payment they will be initially taxed as if they are going to continue to take the same level of payment each month for 12 months. Perhaps surprisingly, it doesn’t even take into account that we are more than half way through the tax year, so there are not 12 months left to receive payments. The emergency tax assumes they are going to have income of 12 x £26,250 (£35,000 less 25% tax-free element) = £315,000 in the year.
This means they get £8,750 tax free (25% of the payment), plus the next £1,042 also tax free as this falls within the monthly personal allowance. The rest is taxed, but they only get 1/12 of the basic rate and higher rate bands, and taxed as additional rate tax payers on the balance. Although at that level of income they wouldn’t have a personal allowance, they would still get it on the first payment as this would then trigger a change in tax code to remove it later in the year. Of course, the individual will be able to claim back the excess tax paid, but this takes time and if they need the £25,000 now, they will have to request a £35,000 payment to get it.
This has been a known problem since pension freedoms came in in 2015, yet still nothing has been done to resolve it. On average HM Revenue & Customs (HMRC) has to repay around £30m of overpaid tax every quarter. This figure doesn’t take into account those that fail to claim it in-year, either because they may not realise they’ve been overtaxed or they are happy to wait. These people will still get their tax back via the normal PAYE process (on the P800 tax calculation).
After five years of waiting it is clear that resolving this over taxation issue is not high on HMRC’s agenda, but it is vital clients are aware of the implications or they could be in for a nasty shock.
Lisa Webster is senior technical consultant at AJ Bell