Ingenious way to take cash out of your pot — without paying a penny of tax

AS tEMptING as it may be to cash in your pension as soon as you can get your hands on it, you could face a huge tax bill if you do.

Any money withdrawn from your pension — after the tax-free 25 pc lump sum — is treated like normal income by HM revenue & Customs.

that’s why the treasury expects to pull in more than £4.1 billion extra tax from investors drawing from pensions in the first three years since easier access was granted in 2015.

yet with patience and planning you could thwart the taxman and take a £100,000 pension without paying a penny in tax. And you may also be able to boost your state pension by around £3,000 a year at the same time.

Money Mail has devised a strategy that would allow you to take up to £15,333 a year from your pension tax-free under current rules. By 2020, you could take £16,666 a year.

As everyone has their own tax allowance, a couple could take more than £ 33,000 a year tax- free from personal pensions. So over six years you could each have withdrawn a £100,000 pension without paying tax.

STEP ONE

tHE key to beating HMrC is to start early — and this means years before retirement.

Even if you don’t pay tax or earn anything, everyone can put up to £2,880 a year into a pension and see it boosted to £3,600 by ‘tax relief’.

By funding the pension of a non taxpaying or low- earning spouse, you could build a cash pot that the two of you can use in retirement.

those who earn can put up to 100 pc of their income into a pension each year, up to £40,000. Basic-rate taxpayers get a 20 pc top-up on everything they invest, while higher-rate taxpayers need only pay 60p to see £1 added to their pot. this is effectively a rebate of income tax already paid.

STEP TWO

tHE second thing to do is move most of your savings into Isas to be sure of tax-free income.

Outside of an Isa, some tax-free interest can be earned. this includes up to £1,000 a year interest for basic-rate taxpayers and £500 for higher-rate taxpayers. But these limits may change in future and could also be eaten up more quickly if interest rates rise.

you and your spouse can each put £20,000 into an Isa every tax year. this is important because it means, when you retire, you can use your personal allowance to the full. this is the amount of taxable income you can receive every year without paying tax.

Currently, the limit is £11,500, but the Government has pledged to raise this to £12,500 by 2020.

STEP THREE

NEXt, delay taking your state pension. Not everyone can afford this, but if you can it will maximise the amount you can take taxfree from any private pension.

the state pension is taxable, even though it is paid without tax being deducted. When you take it, HMrC adjusts your tax code to take account of this, which eats up a large chunk of your personal allowance. the full new state pension is £159.55 a week or £8,296.60 a year. this would reduce your personal allowance to £3,203.40.

the old basic state pension of £122.30 per week (£6,359.60 a year) would reduce your personal allowance to £5,140.

However, your state pension will grow while you defer it. For those who reached state pension age on or after April 6, 2016, the pension is increased by just under 5.8 pc for every year you defer. On the full new state pension of £8,296.60 that’s an extra £479 each year.

If you hit state pension age before April 2016, you could stop it while you draw your private pension and receive a 10.4 pc annual uplift, adding £661 a year to a full pension of £6,359.60.

A word of warning: you won’t get an uplift to your state pension if you are receiving certain benefits such as income support, pension credit or universal credit.

STEP FOUR

WHEN it comes to drawing your personal pension, you are allowed to take a quarter tax-free, then the rest is taxable.

you could take the tax-free portion as a lump sum or take a quarter of each year’s income tax-free.

the latter allows you to keep more pension invested. If it grows in value, then your tax-free sum will increase — but if it were to fall, the sum would be smaller.

this tax year you could take £15,333 without paying tax at all.

the first quarter of that, £3,833.25, would count as part of your taxfree lump sum. the remaining three-quarters, £11,499.75, would be taxable. But you’d avoid tax on it as it falls within your £11,500 taxfree personal allowance. As the personal allowance rises each year, you could increase your tax- free income. After six years you might have taken a £100,000 pension without paying tax on it.

STEP FIVE

dUrING this time, you will have boosted your state pension — which you deferred taking — by around £3,000 a year.

Under the new rules, you could be due an income of around £12,000 a year if you wait six years after retirement age to take it.

those with larger pensions or those who can’t afford to delay taking a state pension could still minimise tax by using the personal allowance as a target.

Whatever you choose, try to avoid taking your entire private pension at once. you could be taxed at 40 pc on some of your pension even if you have been a basicrate taxpayer all of your life.

It could also push your annual income over £100,000 and see your personal allowance cut. In the worst case, this would be like paying 60 pc tax on a chunk of your pension.