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When the new UK pension freedoms were announced last year, Pensions Minister Steve Webb famously quipped that people were free to blow their retirement savings on a Lamborghini if they so desired and the government leapt to defend his comments.
Pension freedoms became a reality for over 55s on 6th April this year and while you might not be planning to buy a Lamborghini, it has possibly crossed your mind that you could dip into your pension pot to buy that second home you’ve always yearned for, or to put down a deposit on a house for your child. Stop right there! Before cashing in your pension and blowing the lot, be aware that the taxman is waiting in the wings to get his hands on your money.
While the government has been busy blowing their own trumpet about how they have revolutionised Britain’s pension system, they have been slightly less enthusiastic about revealing what proportion of your savings HMRC will take if you decide to withdraw the lot, but here are some figures to give you food for thought.
A Lamborghini Aventador will set you back in the region of £250,000. So let’s say you raid your pension pot of £250,000 to buy it. You’ll get £62,500 of that tax-free, leaving you £187,500 classed as taxable income. You won’t get any tax-free allowance on that as your earnings exceed £121,200. For the sake of simplicity, let’s say you have no other income.
Here’s a breakdown of the amount of tax you will pay according to current HMRC tax brackets:
The first £ 62,500 is tax-free
Up to £31,785 is taxed at basic-rate 20% tax giving £6,357 payable in tax
The next £118,215 is taxed at higher rate of 40% giving £47,286 payable in tax
The remaining £37,500 is taxed at additional rate of 45% giving £16,875 payable in tax
So on the total amount of £250,000 the tax bill is an eye-watering £70,518, leaving you £179,482 in your pocket. No Lamborghini Aventador for you!
There is no doubt that the new pension freedoms have empowered investors but with power comes responsibility and smart investors will be taking that very seriously. Suffice to say that Lamborghini will not be deluged with orders! Instead, many people are taking advantage of the abolition of death tax for over 75s to shield pension savings from inheritance tax and pass money tax-free to their families. That’s just one option of many.
What you should do with your pension will depend entirely on your personal circumstances – there is not one single answer for all. With these seismic changes to the pensions system in the UK it is more important than ever to take professional financial advice on the most tax efficient way for you to invest your savings.