Mature gap year: pensions and tax considerations
Usually the preserve of pre and post university students, gap years – whether an extended holiday, three months, six months or even the full year – are increasingly being taking by older Brits.
A combination of higher disposable income, greater flexibility at work (or no work commitments) and a changing society have driven the grown-up gap year trend.
Statistics from Saga’s latest Travel Spending report revealed that 28% of holidays taken by over 50s are for longer than the typical fortnight:
While it’s easy to get carried away with holiday planning and spending to ensure you have the time of your life, it’s important you set aside some time to consider the impact of such an extended holiday on your pension and tax situation.
Below, we explain more…
State pension impact
The actions you need to take will depend upon whether you’re employed, self-employed, saving for your pension or already receiving a pension income.
In order to qualify for the new or flat rate state pension (maximum £159.55 a week for 2017/18, rising to £164.35 in 2018/19) you need to have made 35 years’ of National Insurance Contributions (NICs). In order to get anything at all under the newer pension scheme introduced in April 2016, you need to have at least 10 years of NICs.
Therefore, if you’re taking time out of work and aren’t earning an income, you won’t accrue these qualifying years for state pension purposes.
Ammo Kambo, financial planner at Brewin Dolphin, says it is possible to check your state pension to see your forecast and any gaps in your NIC record.
“You should find out the costs involved to make voluntary contributions, to make good any shortfall”, he says.
“You may want to consider this top up if you plan to take time out of work. If you do stop accruing ‘qualifying’ years, you may not have the maximum 35 years at state pension age.”
Another point to note regarding the state pension is that a gap from working could also impact the ability to claim benefits on return to the UK.
Private or workplace pension impact
For those in employment, most sabbaticals tend to be unpaid and the amount of contribution that can be paid into your pension will depend on what your earnings are, according to George Houston, technical director at Mattioli Woods.
If earnings stop for a period, your pension contributions may also stop, but it is possible to make contributions into a workplace pension if you take time out of work. As such, you should check with your employer first whether it will continue paying into your pension.
Whether you should continue paying into a pension contribution largely comes down to affordability.
Houston says: “You will still have the ability, regardless of any earnings you may still have, to pay up to £3,600 gross, £2,880 net of basic rate tax.
“Pensions remain one of the most tax-efficient investments we can make, so they are worth considering, although only if they can be afforded.”
He added that self-employed individuals will also have similar points to consider on affordability and the requirement to have earnings to justify contributions higher than £3,600.
“I guess a bigger consideration is a loss of client loyalty where you’re not still providing services to existing clients. You may have a locum in place to do this, sure, but a break of any extended amount of time might put this existing customer base at risk,” Houston warns.
For those who are already drawing on a pension income, Houston explains that you can still pay up to £3,600 in a year towards your pension. He says for defined benefit (DB) schemes, you will most likely not be able to accrue further benefits in that environment, so you may need to pay into a defined contribution (DC) scheme.
However, he warns: “If you have earnings that can justify higher contributions, where you have drawn benefits flexibly from a DC scheme, you will need to be mindful of the Money Purchase Annual Allowance, which will restrict the amount you can pay to £4,000 a year.”
Kambo also provides a warning to DB scheme members: “It would be sensible to check with your employer that you will still retain membership of the same scheme on your return, and not directed to a newer, potentially inferior scheme such as career average earnings DB scheme or DC.”
Employees taking a break from work will mean funding the trip at a time when you’re giving up an earned income.
“This is likely to mean funding the trip from savings, investments or possibly a pension pot. Taking funds from these sources will not only impact how much future income can come from these sources, but taking funds will have different tax implications depending on the source,” according to Gill Philpott, tax and trust specialist at Ascot Lloyd.
She says: “For example, selling investments could trigger capital gains tax charges unless ISA funds are used. Taking money from pension pots could be tax efficient if accessing a tax free lump sum, while taking income could trigger income tax charges.
“Each individual will need to review their own tax position and consider earnings and other income or gains in a tax year in which they realise investments or withdraw from a pension pot to fund a trip.
“Timing could be key; leaving earlier in a tax year will mean less earned taxable income and could even give rise to a tax repayment, which could be useful. But investment considerations are important, taking funds from tax efficient wrappers which may not be able to be fully replaced on return; or using pension pots which will reduce future pension income depending on opportunities to top the pot up on return.”
Philpott suggests one possible source of income during your trip is to rent out your home, reducing your reliance on other income sources and therefore minimising the tax impact, but rental income is taxable income which means you may be required to file a tax return.
She says: “As ever with making investments or in this case selling investments, current tax costs need to be balanced against future investment returns and the impact on income to continue to fund living costs on return from a trip. Working with an adviser to provide tax and cash flow modelling information is very useful here.
“On a practical point there may be a need to file a tax return or deal with HM Revenue & Customs after embarking on the trip. Ensuring your tax affairs can be dealt with online would be a useful and practical step.”
A final point to consider in relation to taxation is whether you plan to work while away as this could involve tax in more than one jurisdiction.