Investments / Financial planning / News / Pensions

Will accessing my pension create an IHT bill?

Building a pension is a tax-efficient way of saving for your retirement. But careful planning may be needed to avoid generating an unwelcome Inheritance Tax bill when it comes to accessing your pension funds. Huw Wedlock, Director of our Singapore operation, explains what to be aware of.

UK pension savings are a great concept, especially given that the government adds another 20% to what you put in, and (if you’re employed) your company may make contributions too. And don’t forget that any investments in the scheme grow free of Income Tax and Capital Gains Tax. In addition, any funds in your UK pension scheme are protected from a potential 40% Inheritance Tax charge.

There are other benefits too; in your working life contributing to a pension scheme reduces the amount of tax you pay and enables you to draw a taxable income in retirement when your other sources of taxable income are generally reduced.

So, can you take all of your money out of a pension fund?

In April 2015 the government changed the rules to make it easier for you to take money out of your pension fund; it’s now possible to have full access to your pension fund from age 55. But just because you can take out all of the funds from your pension fund does that mean you should?

The drawbacks are that any amounts taken out still attract UK Income Tax; so there could be a significant bill, perhaps of 40% or 45%, to pay for accessing your pension fund. In addition, those funds could then fall within your Inheritance Tax estate and be exposed to a tax of 40%. As well as losing protection from Inheritance Tax, those funds in your hands have also lost the protection from Income Tax and Capital Gains Tax on future investment growth.

The importance of seeking advice

It’s important to think carefully about what you are going to do with the funds withdrawn from your pension fund and what impact this will have on your income in your retirement. Worryingly, in 2020/21, around 2,777 pension pots worth over £100,000 were fully cashed in, and six in 10 of these were withdrawn without any advice being taken. The government’s own figures show that around £37 billion of funds have been withdrawn from pension funds since the flexible access rules were introduced in 2015.

Given the protection from UK taxes on the funds in your pension and any future investment growth, is it really a good idea to be accessing those funds? If you have a need for cash are there other sources you could access? Generally, from a tax perspective, it’s sensible to exhaust funds that are already facing that 40% Inheritance Tax charge. The funds outside that Inheritance Tax charge in your pension pot really should be the last funds accessed in your retirement.

Usually, you have full access to your UK pension funds from the age of 55. But, given the UK tax protections that go hand in hand with UK pensions, it’s useful to consider whether it’s really the right thing to take all of your money out of your pension scheme.

Seeking professional advice is very important before taking any actions with your pension. To discuss your pension plans in more detail please contact your nearest office.