Great Idea for Tax-Free Cash

Great Idea for Tax-Free Cash

Having a high-value pension is great news. However, any income drawn from it is taxed as income for the pension holder alone. This makes it difficult in some cases to withdraw income in a tax-efficient way without paying higher rate income tax.

Due to this, it may be a plausible option to take your full tax-free cash from your pension and re-invest it elsewhere to make use of some of your annual tax-free allowances that may be underutilised.

One of my go-to allowances is the annual capital gains tax allowance. In the tax year of writing, 19/20 tax year, the annual CGT exemption is £12,000 per person. This is higher than the personal allowance for income tax. However, it’s rarely used.

To make use of this, you could consider taking the maximum tax-free cash from your pension and investing it as a cash holding. This would mean that any investment return would be taxed as capital gains, and as a result use up some or all of your annual CGT exemption. It creates a great additional tax-free income each year.

If you are married, you could even spread the investment over both you and your partner and make the most of two lots of CGT allowance totalling  £24,000 a year.

To further increase the tax efficiency of this strategy, you could slowly move some of the cash over to your ISA each year. This would then continue to generate tax-free income and would also create some tax-free investment growth as well.

Clearly the above strategy would require the underlaying investments to perform in each tax year.

The final added benefit for someone with a high value pension would be that the pension value would be reduced.  As a result, this would limit the investment growth that would otherwise have exceeded the pension lifetime allowance.

The downside is that the funds would now form part of your taxable estate for inheritance tax (IHT) purposes, as it would be leaving the shelter of the IHT-free pension wrapper. Therefore, some further IHT planning would be required also.

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