Can You Make a Quick Profit From a Pension?

Written by Karen Bryan

£20 notes close up1 240One of the biggest attractions of saving into a pension is you can get tax relief on the payments. You can put up to £3,600 gross (after tax relief) into a pension, even if you have no earnings. If you wish to attract tax relief on higher pension payments, you need to be working and then you can get tax relief on earnings of up to £40,000 per annum.

With the changes to pension access starting on 6 April 2015, it’ll be possible to take your whole pension pot as cash. You will be able to take 25% as a tax-free lump sum, but the remaining 75% will be taxable, if your total income is above the annual personal allowance (that’s the amount of income per year that you can have before being liable to pay income tax).

Despite the fact that I bought an annuity a year ago, these changes to pension access have prompted me to consider starting a new pension.

I wondered if it would be possible for non-workers or low earners, aged between 55 and the State Pension retirement age, to put a few thousand pounds into a pension pot, attract the 20% tax relief on the contribution, and then do a quick turnaround, taking out 25% as a tax-free lump sum and the remaining 75% of the pension pot, which could be offset against any unused personal allowance.

Let’s do a worked example for someone aged 59 working for a few hours a week, with a small private pension, plus some savings to top up their income during the pension turnaround. Let’s say that they have earnings of £4,000 and a pension of £3,600,. From 6 April 2015, the annual personal allowance will be £10,600. That’d mean that they’d still have £3,000 of their personal allowance left after deduction of their earnings and pension income.

They put a total of £4,000, 100% of their earnings for that tax year, into a pension. This would cost them £3,200, with £800 added as tax relief. As soon as possible, they take £1,000 (25% of the £4,000) as a tax-free lump sum. That leaves £3,000 (75% of £4,000) which is liable to income tax. However, they still have £3,000 left in their personal allowance, so there’d be no income tax due on the £3,000 taken out from the pension.. As they paid in £3,200 but got back £4,000, they’ve made a profit of £800.

Sounds great, but the sticking point is going to be any charges and/or fees made by the company with whom you hold your pension pot, which will eat into the profit.

The first new product which I’ve observed designed for the new flexible pension access arrangements is Hargreaves Lansdown’s ‘New Drawdown’ plan. The maximum which you can claim in tax relief per year for this (or any other drawdown plan) once you start to take income, is £10,000.

I’m not sure exactly how long the process would take from when you make the initial net payment into the pension until you could get your cash back. But I did read on the online pension application form on the Hargreaves Lansdown website that it could take up to 8 weeks for the tax relief to appear in your pension account.

Although the Hargreaves Lansdown product has no set up fee, no transfer in fee, and no annual drawdown fee, there is a charge of £295 plus 20% VAT, which equates to £354, if you withdraw the full amount within 12 months of opening the account.

In one swoop, you’d lose a big chunk of your £800 profit given in my worked example above. Still a profit of £446 would mean some welcome additional income, if you could be bothered doing the paperwork.

I appreciate that Hargreaves Lansdown are running a business, and that they are not going to offer a free service to people who want to take advantage of tax relief on pensions, But I think that the fee is a bit high for the work involved, especially for those with small pension pots.

I wondered about leaving some of the cash in the New Drawdown account for 12 months to avoid this fee, as the closure fee after 12 months drops to £25 plus VAT. I couldn’t see anything on the Hargreaves Lansdown website about a minimum balance requirement for the New Drawdown account, but obviously you’d need to check this.

You could keep the money remaining in the pension pot in a cash account, earning no interest (although that might not be so bad if inflation is really low, or even negative). There’s no fee for holding a cash pension account with Hargreaves Lansdown.

Or you could risk putting your pension pot into an equity based pension fund for 12 months, which might return a profit or a loss, plus there would be a management charge.