This year’s budget included a few eye-catching announcements, including the decision to increase the ‘small pot’ pension fund from £2,000 to £10,000. Part of the government’s drive to make pensions more flexible, the new rule also had the effect of creating an interesting opportunity for shrewd investors. Although we’re talking about a loophole that has actually been acknowledged by HMRC, it won’t be formally addressed until April 2015. And that means you have a perfectly legitimate window in which to act, if you’re currently employed and aged between 60 and 75. Let’s take a scenario in which you open a personal cash stakeholder pension and pay £8,000 into it. HMRC will top this up to £10,000, accounting for the automatic base tax relief of 20%. It’s possible – after a cooling-off period – to take the balance as cash under the small-pot rules. Previously, you were allowed to draw it as a lump sum on two occasions, but under the new rules, you’re able to do it three times.
Now for the maths. Because only 75% of the £10,000 is taxable, £2,500 remains tax free. And after you’ve paid £1,500 on the remaining £7,500 (at the 20% basic rate), you’re entitled to the £6,000 that’s left.
Your total pot is therefore worth £8,500, giving you a profit of £500. So if you go through the process on two further occasions, you’ll be £1,500 wealthier before provider charges. (If you pay tax at the highest rate, you would actually have a potential gain of £3,375, although there’s a delay in tax relief as it would be processed via your next return.)
The truth is that this loophole always existed, but with the £2k cap on the small pot, pension investors were unlikely to see any significant benefit. Now the figure is five times as high, people are paying attention for the first time.
One word of caution. If you approach a pensions adviser about this arrangement, it’s likely their fees would eat substantially into any potential profit. A more sensible course of action might therefore beto speak to your accountant. Although we’re not authorised to advise on specific products, we’re always happy to give you general advice and talk you through the tax implications.
If you would like to discuss anything related to this article please do not hesitate to call Barnett & Turner on 01623 659659 or email Jonathan at jwilson@barnettandturner.co.uk