If tax-free cash is delayed beyond age 75 and the person dies before taking it, the tax-free portion is lost.
Many retirees don’t realise that after age 75, pension rules change dramatically – and not in your family’s favour. Without the right planning, a significant chunk of your hard-earned pension funds can be eaten up by tax, particularly with pensions being subject to Inheritance Tax (IHT) from April 2027. Taking your 25% tax-free lump sum in time can help reduce the tax burden and add flexibility when planning your legacy.
75: The tax tipping point
If a pension holder dies before age 75, unused pension funds can typically be passed on free of income tax. After 75, any pension money passed to beneficiaries would then be taxed at their income tax rate. In the latter case, income tax is due on all unused pension funds, including any portion that could have been taken as tax-free cash during the lifetime of the pension member.
Securing the tax-free benefit
You don’t lose access to tax-free cash on your pensions after 75, but taking your lump sum before that milestone age ensures you don’t risk incurring unnecessary tax bills for your beneficiaries. Let’s say you have a £400,000 pension and £100,000 available tax-free. In the event of a death after 75, and without the tax-free cash being taken, the entire £400,000 would be subject to income tax, resulting in a net pension value of £240,000 for beneficiaries with a 40% income tax rate. If the tax-free portion had been taken, £40,000 income tax could be saved and the net value boosted to £280,000 (see graph above).
Maximum tax-free cash
You can usually take up to 25% of the amount accrued in any pension as a tax-free lump sum. The most you can take is £268,275 (the lump sum allowance). In special cases, if you hold past protections, you may be entitled to higher tax-free lump sums.
You don’t have to start taking taxable income from your pensions to get the tax-free cash. It’s enough to move the pension funds into a drawdown account and choose to take no income.
What to do with tax-free cash
Tax-free cash taken can be drip fed into an ISA, or any other tax-efficient investment, to flourish tax-free. With the upcoming changes to IHT looming, pensions are due to form part of the estate from April 2027. Taking your tax-free cash opens up options for mitigating this through gifting and/or specialist investments.
[i] A financial adviser help you assess your income needs and plan for retirement. Call 03300 564 446 to speak to a Lumin expert.
