My defined-contribution pension pot is invested.
The pension fund will likely be used for care if I need to enter a nursing home in the final stages of my life.
In this case, if the care home fees are greater than £50,000 per year, will I have to pay a higher rate of tax when I draw down funds from my pension pot?
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Later life planning: Will pension withdrawals to fund £50k-a-year care home fees be taxed at the higher rate?
Steve Webb replies: The rules surrounding care funding may soon change. This is why it might be worth taking a moment to remind yourself of them before starting to think about ways you can fund your care.
Please note that the comments and figures in this column only apply to people who live in England. The system is slightly different for residents of Wales than for Scotland.
Presently, you can go to a care home if the local authority determines that you have the need for that type of care. There will also be an assessment of both your regular income as well as your capital.
On income, the council will expect you to use your own resources such as state pensions, private pensions and so on, to pay care costs but if your income doesn’t cover the full cost they will generally pay the difference.
They will also make sure that you have a modest amount left (currently £24.90 per week) to cover personal expenses.
On capital, any savings below £14,250 are ignored. If you have between £14,250 and £23,250 they will assume an amount of income you could be deriving from this capital and will reduce the amount of support by this amount each week.
Steve Webb: How to ask former Pensions Minister questions about retirement savings.
But if you have more than £23,250 you will be disqualified from any support.
The main changes proposed by the reforms are:
– The amount of capital which is completely ignored will rise from £14,250 to £20,000
– The capital limit above which no help is available will rise from £20,000 to £100,000; but income will continue to be ‘imputed’ on capital between £20,000 and £100,000, so those with relatively large amounts of capital will get a lot less help each week than those with less capital
– There will be a new lifetime limit of £86,000 on social care, above which further costs will be covered by the Government
Learn more about these changes by clicking here
Now let’s look at your current situation. You envision a scenario where you are forced to pay for your care in a home.
Assume you have taken your lump-sum tax-free in retirement. This means that any money you take out of your pension pot could be taxable.
You would tax your monthly withdrawals from your pension to cover your care home expenses if they were taken out of the pot every month.
This is a good time to expect that you will be receiving a state-provided pension. Therefore, your state pension and any lump sum retirements could all contribute towards your year’s taxable income.
If the total amount exceeded the starting point for higher rate tax – currently £50,000 – then any excess would indeed be charged at 40 per cent, even though you are spending the money on care costs.
Due to the large amount of assets that we’re discussing, I encourage you strongly to seek financial advice early on about your options.
Care funding can be a complicated matter but there are some financial advisors who specialize in it, such as members of Society of Later Life Advisers.
You should not do any artificial things to help reduce care costs. However, complex decisions must be made.
A financial adviser can help you decide if your money should be left in your retirement pot for future care expenses or whether it could more effectively be used elsewhere.
It might also be worth being aware of a financial product called an ‘immediate needs annuity’.
The policy is taken out at the moment of your entry into residential care. In return, the insurer guarantees to cover all your healthcare costs until you die.
While any money taken out of your pension to purchase the product will be taxed, it would give you the assurance that all your future care requirements would be covered.
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