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Final Salary pension pitfalls – don’t pay more tax than you need to

Calculator on a table sitting next to post-it notesTax calculations can be very confusing and so can the rules regarding tax liabilities on final salary/defined benefit pensions. Because they are confusing, some people may choose to ignore them in the belief that it will be all right on the day and this will end up with them sleepwalking into an unnecessarily large tax bill.

So what should you do? To begin with, establish whether your final salary (defined benefit) pension income is likely to exceed £37,000 a year? If it does, you’ll need to find out just how the 55% or 25% Lifetime Allowance Tax Charge could affect you.

Most people in this position understand that their final salary pension will be tested against the pensions Lifetime Allowance when they take their benefits. However, what many people don’t realise is that the value for Lifetime Allowance purposes is calculated by multiplying the final salary income by 20 and then adding on the tax free lump sum. Personal pensions and Additional Voluntary Contributions (AVCs) are then added on top of this.

At this point many people will be in for a nasty shock if this total is over the current Lifetime Allowance of £1m because their final salary income could be significantly reduced.

Over the £1m limit, any lump sum taken will be taxed at 55 per cent and pension will be taxed at 25 per cent plus your normal rate on income tax.

So if you are on track for a final salary pension (with no separate lump sum) of more than £50,000 a year or a salary-related pension in the region of £37,500 plus the maximum tax-free cash lump sum, then you’re likely to be affected by the lifetime allowance tax charge. What’s more, if you have AVCs or other additional personal pensions, the tax charge could be much worse and could affect your other smaller pensions too.

Those with long service in the Teachers’ Pensions, Universities Superannuation Scheme, local council, Government, NHS Pensions or the military have been particularly harshly effected by the Lifetime Allowance Tax charge and should always seek specialist advice before drawing benefits.

How, when, and the order you take your pension benefits can have a huge impact on the amount of Lifetime Allowance tax charge you will need to pay but there is action you can take which can help minimise the tax.

If you think you may be affected by the Lifetime Allowance and would like to find out how to avoid paying out more tax than you need to, please contact Rachel Allen at PKF Francis Clark Financial Planning for a no cost meeting to consider your options.

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