A nice pensions loophole

by Ed Bowsher on 17 February 2012  |  6 comments
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Small pensions pots have one significant advantage.

Some new figures from Skandia are a useful reminder that small pension pots aren't all bad.

Basically, if your pension savings are sufficiently low, you can withdraw your whole pension pot in one go once you reach the age of 60. If your pot is worth £18,000 or less, you don’t have to buy an annuity and you don’t have to go into income drawdown. Instead you can just take the money and you may not have to pay much tax.

This concession also creates a useful  loophole if you’re  someone with little or no personal income but who has access to capital for investment. Perhaps you’ve been a non-working spouse based at home for many years.

In this scenario, if you’re approaching retirement, it may make more sense to save via a pension than via an ISA.

Just save a small amount each year for a few years, and you could accumulate pension savings of up to £18,000, and you won’t have to buy an annuity or go into drawdown.

You might be thinking: but if someone isn’t working, how can she pay money into a pension pot. The answer to that is that you can still invest up to £3,600 a year into a pension. The government will pay 20% income tax relief so a person only needs to invest £2,880 for a total contribution of £3,600.

Look at this table from Skandia:

The saver has invested £12,500 over five years and ended up with a pot worth £17,088.

The saver could have saved the money in an ISA, but then she would never have had the tax boost paid by the government at the time the money was saved. It’s true that you don’t have to pay tax when you withdraw money from an ISA, but in the scenario outlined above, the saver doesn’t have much income so she probably won’t have to pay much tax on the £18,000 anyway.

And at the very least, she’ll be able to take a quarter of the pension pot as a tax-free lump sum.

So small pensions can be more useful than you might expect!

• ·         When I talk about a pension pot, I’m talking about money that has been saved for retirement via a defined contribution pension.