Only one third (35 per cent) of UK customers in drawdown are taking their full income allowance, according to research from Skandia.
This means two thirds (65 per cent) of people with money purchase pension savings have the opportunity to potentially improve their tax efficiency, and hence their overall long-term wealth.
This can be achieved by opting to use some or all of their available pension income to build new untouched pension savings.
Individuals under 75 can achieve tax relief on contributions into a pension of up to GBP3,600 each year, even if they are not working. If someone is working they will qualify for tax relief on further contributions, subject to the annual contribution allowance and the level of their earnings.
Using the pension income to invest into new pension savings will have many benefits but no real downside. The income tax paid when money is taken from the existing pension is offset by the tax relief received when invested as new pension savings.
There are several advantages to using unused drawdown income in this way. Firstly, as the new pension fund is not deemed to be “in drawdown” it is not subject to the 55 per cent tax liability on lump sums paid to beneficiaries on death before age 75. Secondly, the newly created pension fund will provide a further 25 per cent tax free lump sum as part of their future retirement income (provided the savings are within the Lifetime Allowance).
Adrian Walker, Skandia’s pension expert, says: “There is a great opportunity for those in drawdown who have taken their tax free lump, but are not using all of their available income to improve the tax efficiency of those savings with no real cost to themselves. Not only does this planning reduce the potential tax liability for their beneficiaries on any available lump sum if they die before 75, it will also build another 25 per cent tax free lump sum, helping to provide greater income in the longer-term. This is a great opportunity for pensioners who may not be taking the maximum income allowance each year to build a more effective retirement income strategy.”