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A taxing question

25 September 2019

Would you rather all your money was taxed or just the growth? A fairly simple question, says Les Cameron, head of Technical, Prudential.

The question ‘would you rather all your money was taxed or just the growth?’ will probably get a quick answer! Just on the growth of course – who’d want to pay more tax?

And this is the question that should be being asked of people with unvested pension pots who reply “I don’t need the money it’s for the family”.

Age 75 is a key point in the tax journey of a defined contribution journey. The growth on drawdown money is tested against the LTA as are any remaining unvested pots.

The question for some might be, is arriving at age 75 with an unvested pension pot the best position to be in? Because the other key change at 75 is the taxation of death benefits. On the stroke of midnight on their 75th birthday a client’s death benefits go from being tax free to being taxed at the recipient’s marginal rate.

Where they have an unvested pension they will normally have access to 25% of it tax free. If they withdraw it and invest outside the pension only the growth will be taxed.

So, by investing in a way that means any tax liability falls on the beneficiary you can make them richer.

Reinvesting in another tax exempt wrapper such as an ISA or offshore bond could give the same investment return as the pension, as with the wide availability of open architecture wrappers, the investments could be the same as those in the pension.

The decision between the wrappers will clearly be down to personal circumstance. Allowance availability, IHT position, the desire to use trusts or the ability to assign in future will all influence the decision.

The simple premise is illustrated in the boxes.

The question is: Can better outcomes be achieved – because they’ve only had the growth taxed and not the capital?

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