Pensions have always been a tax-efficient method of saving for retirement, but for many people the ultimate need to take income as an annuity has been seen as a deterrent to making pension contributions.
The tax benefit of making pension contributions is that HMRC adds tax to the pension fund of contributions made by individuals, and for higher-rate tax payers there is also a reduction in their personal tax bill.
For example for every £800 pension contribution, HMRC will add £200 so the fund will contain £1,000.
Higher-rate (40%) taxpayers will also get a reduction in their tax payable of £200. This means that their pension fund of £1,000 will effectively have cost them £600, but that money is in a fund that is not immediately available to the individual and the rules around accessing it have strict requirements.
However, from next April there will be more ways to access the pension fund.
The income rules and restrictions on capped and flexible drawdown will to all intents and purposes disappear.
From the age of 55 you will be able to take your money with much greater flexibility.
You will still be able to take the first 25% tax free, with the balance taxed at your marginal rate.
However, the biggest difference will be that you can take out as much of your money as you want, when you want.
This ability to take the balance of the pension and pay tax on it gives rise to interesting tax planning opportunities for those with incomes that vary.
One possible scenario is combining the new pension rules with the current annual investment allowance, for instance planning capital expenditure to coincide with taking funds from a pension.
In a farming situation this might mean drawing pension funds and buying a combine. The combine could be written off against farm income and may create a situation where the tax payable on the pension withdrawal is reduced or even completely reduced to nil.
Note that it does not have to be the same money that is used to buy the equipment as was taken from the fund.
Of course the purchase of machinery should be driven by sound commercial needs for the equipment rather than as a means of saving tax, but if the expenditure is planned anyway, then planning the timing can bring the added benefit of tax savings.
Following on from the above changes, the Government has also announced that it will abolish the current 55% pension death tax charge.
Under the new rules, if a person who is under the age of 75 dies they will be able to give their pension pot to any beneficiary tax free, including if the pension is already in drawdown.
There will be no tax when the pension is passed on, and the beneficiary will not have to pay income tax on the money they withdraw from the pension.
When an individual over 75 dies, beneficiaries of the pension will only pay their marginal tax rate on drawdowns from the pension, or alternatively a 45% tax charge if taken as a lump sum.
It is planned that this charge will also move to the marginal income tax rate from April 2017.
Beneficiaries will also be able to access pension funds at any age, and the lifetime allowance, currently £1.25 million, will still apply.
Although the new rules come into force in April 2015, beneficiaries of anyone who dies before that date can still benefit so long as payment is delayed until after that point.
Therefore, as well as there being more income tax planning involving pensions, there may also be some inheritance tax benefits to be obtained.
Of course, for most people the pension pot will be required for income in old age or retirement, and therefore any solution will need to be individually tailored to create a bespoke ‘retirement’ plan that meets the need of that person.
This will also need to be reviewed throughout ‘retirement’ to ensure that you remain on track.
In the majority of cases, individuals will need to take independent financial advice to ensure that they make the most of their pension savings.
* Robin Dandie is a partner, and head of agriculture, at Johnston Carmichael.