The economic climate has seen large numbers of pension savers draw pension tax-free cash early, whilst continuing to work and electing to leave their balance pension fund invested until retirement.
Where savers continue to work and do not require additional income, it would seem to make sense to leave pension funds intact for the future and avoid unnecessary income tax liability on pension income.
However, this may not be the most tax efficient approach as:
- The balance of funds are subject to income tax when pension income is eventually drawn,
- In the event of an untimely death, the balance funds could be subject to a tax charge of up to 55%.
As many people now extend their working career or draw cash early, recycling pension income has gained popularity and can make a pension fund more tax efficient. Rather than leave the remaining pension fund invested, consider drawing the maximum income and paying the monies straight back into a pension.
The pension income would be subject to income tax at your highest marginal rate and by reinvesting the gross equivalent straight back into a pension, the additional income tax paid is recouped through equivalent tax relief on pension contributions. The exercise is therefore tax neutral.
By planning ahead and repeating the exercise for a number of years, the funds paid back into a pension become more tax efficient, as:
- Prior to the benefits being drawn, on death, the full amount would be paid as a tax free lump sum and out with your estate for inheritance tax.
- An additional 25% tax free cash sum would be payable on the funds reinvested.
With some simple planning, a pension fund becomes more tax efficient saving money over the longer term.