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Using a Fixed Term Annuity to ‘cash out’ your fund

While the new pension reforms allow you to take your entire pension fund as cash, taking it this way could leave you with a hefty tax bill. Although the first 25% is tax-free, the remainder of your fund is subject to income tax at your marginal rate, which for some could be as high as 40% or even 45%.

If you have decided to withdraw your whole fund, a potentially more tax-efficient way to access your money is to use a fixed term annuity to withdraw the whole taxable amount over several tax years, taking advantage of your annual tax-free personal allowance (currently £11,500 for most people). Depending on your fund value, other earnings and your individual circumstances, you might not have to pay any income tax at all. Here’s an example to demonstrate how a ‘cash out’ based fixed term annuity, as detailed above, might be used:

Mr A was 64 and was due to retire in less than one year’s time. He had a final salary pension along with a personal pension pot worth £37,346.

Mr A decided he would like to take all of his personal pension pot in cash and after taking his 25% tax-free cash sum (£9,336), the taxable balance was £28,010. While still working, Mr A was a higher rate taxpayer and he was very concerned that the whole of the balance would be taxed at 40% resulting in a tax bill of £11,204 on this money.

Rather than reverting to a lifetime annuity paying a small amount of income for the rest of his life, to minimise his tax liability Mr A decided he would like to use a ‘cash out’ fixed term annuity to take the whole taxable amount over four years. This gave him a regular annual payment of £6,928 payable in arrears.

At retirement, Mr A’s final salary pension was going to be his only source of income and as this would be considerably less than his salary, Mr A calculated that he would only have to pay tax at 20% (£1,385 a year) on each of the four years’ payments. Instead of paying tax of £11,204, Mr A would thus only have to pay tax of £5,542 saving him £5,662 in total.

Mr A was also attracted to using a fixed term annuity as the payments, although when totalled together were slightly less than the £28,010 taxable balance above, were guaranteed and without any investment risk.

Before taking all your pension savings in cash, it is important that you consider your overall financial arrangements to ensure you will have adequate means to support yourself and your family for the remainder of your life.

Please note that Retirement Line are not tax specialists and work on a non-advised basis. If you have any concerns, please contact a professional accountant or an independent financial adviser.

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