How doctors and dentists view and use their pensions has changed since ‘Pension Freedoms’ came into being in March 2015. If you’re a medic thinking of retiring, here’s a quick overview of what you can and cannot now do with your pension.
Which doctors and dentists can take advantage of Pension Freedoms?
For the most part, Pension Freedoms affects anyone with a pension in a defined contribution scheme, a personal pension scheme, a free-standing additional voluntary contribution scheme (FSAVC), or an additional voluntary contribution scheme (AVC).
Many doctors and dentists have been contributing to a personal pension or an FSAVC scheme for many years now and for good, sound reasons:
- For the tax relief they receive on their contribution
- For the tax free lump sum at retirement
- For the chance to enhance their retirement income
- For the option to take benefits at age 55 and, in so doing, perhaps give themselves the chance to go into semi-retirement ‘early’.
No-one knew 10 or 20 years ago that the very same pensions would become even better and start to offer an unbelievable financial opportunity that could not only provide a flexible source of income, but also be an extremely powerful inheritance tax planning tool.
Does Pension Freedoms apply to the NHS Pension Scheme?
The NHS Pension Scheme is a final salary scheme that provides guaranteed benefits in a pre-ordained way.
Pension benefits from the NHS Pension Scheme are therefore not affected by the Pension Freedoms reforms with one exception – you are now allowed to exchange your pension income for a bigger tax-free lump sum at retirement.
What your powerful pension options are thanks to Pension Freedoms
Let’s recap. As of the 6th April 2015, as long as you’re over the age of 55, you can take 25% of your pension fund as a tax-free lump sum up to a quarter of your lifetime allowance.
You don’t have to take the lump sum all at once either; it can be drawn down on a monthly, quarterly, half yearly, etc basis. It means that your tax-free pension income can form part of your taxed day-to-day income, and you no longer have to buy an annuity in order to have a set income for the rest of your life.
The remaining 75% of your fund (the “income bearing” bit) will be taxed at your marginal tax rate whenever/if ever it is drawn down.
Flexibility to take what you want, when you want out of your pension
Taking your 25% tax-free lump sum over a period of time is called phased drawdown. It not only gives you a huge amount of freedom to dictate how much income you draw from your pension and when, you also have a fantastic opportunity to manipulate your income in the most tax-efficient way.
Dr Cash retires at 55 with a pension that pays £25,000 per annum accrued in the 1995 NHS Pension Scheme. He also has £120,000 invested in a personal pension.
Dr Cash decides not to take his NHS Pension because of the early retirement penalties he’ll incur. He can though take a £30,000 (25%) immediate or phased tax-free lump sum from his personal pension, and however much he wants as income (taxed at his marginal rate) from the remaining £90,000. He could even completely empty his pension pot and take the whole £90,000 out (subject to income tax); although it must be said, this isn’t exactly the most tax efficient route.
It’s worth bearing in mind that not all pension scheme rules have been amended to take account of the new flexibilities. If you haven’t had your pensions reviewed since 2015, now’s the time to check you have the most up-to-date flexible arrangements in place.
So that’s all great news! But things get potentially better still when we think about passing on wealth to the next generation.
Powerful inheritance tax planning opportunities
By far the biggest change to pensions under the new rules is the ability to leave your pension to whomever you please when you die. That could be your spouse or partner, your children and/or your grandchildren.
What makes this an even more powerful option is that your pension fund will sit outside of your estate when it comes to calculating how much inheritance tax is owed! I have clients who are not touching their accrued pension pots because they see them as a way of passing on wealth to future generations.
There are rules to follow (as you would expect) but they are not punitive, in my opinion. You do have to be aware of the lifetime allowance when you’re considering the potential benefits but, for the examples below, I have assumed there are no lifetime allowance ‘issues’.
If you die before the age of 75
The whole of your pension fund can be paid as a tax-free lump sum to any number of beneficiaries. As long as the payment is made within 2 years of the pension scheme being notified of your death, there is no inheritance tax to pay and no individual income tax.
If you die after the age of 75
All your pension funds pass into a ‘beneficiary pension’ environment. Whilst there is no inheritance tax to pay on the fund and the benefits can be accessed by any number of beneficiaries, they will pay income tax at their highest marginal rate.
However, let’s say that you had nominated a grandchild as a beneficiary and they were a non-taxpayer. The grandchild has their own personal allowance which is tax free up to nearly £12,000pa – there’s a great tax planning opportunity right there!
What is fundamentally important to being able to leave your pension to your loved ones is to ensure that you have nominated beneficiaries and that the pension scheme rules allow the flexibilities to pass on the pension.
My advice would be to meet your local adviser, talk through the issues raised above, and ask them to help you complete nominations and check that your pension is allowed to be passed on.
Will you be taking advantage of the financial opportunities Pension Freedoms give you? Let us know by adding a comment below.