Tax on pension pot

steve1500

Sorry if this has been posted elsewhere, but cannot see anything.


For simplicity of numbers. I have a pension pot of £50,000


If I take the lot, will the amount I receive be roughly £36400?


I have calculated the tax as £6400 20% on 32,000 & £7200 40% on the remaining 18,000.


If because of other earning during the tax year I have underpaid the tax, will I get the bill at the end of the tax year, when HMRC know all of my taxable income?


Thanks

HappyHarry

What will be your income next year, aside from this pension pot?

jamesd

You can forget about the chance of underpaying tax by a lot. The system is set up so you have to do convoluted things to avoid massive overpayment of tax on taxable lump sums.

You can use forms to reclaim excess income tax if you have withdrawn all of the money from the pension pot. Use Reclaim Form P50 if you have no other pension/PAYE income or Reclaim Form P53.

If you have not received income from this pension pot before the pension provider will charge PAYE income tax as if you are taking out £50,000 a month for a whole year. This means that they will deduct some income tax at 45%.

If you want to avoid that large income tax overcharge you can take an initial small payment then a week or so later call HMRC and tell them about your planned income for the year, asking them to send appropriate tax codes to all of your PAYE income sources to allow for that. Once the pension provider has received the new tax code they won't do such dramatic overcharging, provided their systems are able to report lump sums and regular income differently. If they can't do that individual reporting the only way to avoid the large overcharge is to take the money as regular income instead of a lump sum.

It's pretty wasteful to take £50,000 when some of it will be taxed at higher rate. Usually better to do it at the 20% rate only unless you have a hit man demanding money from you under threat of death.

Pension income is just normal taxable income paid under the PAYE system. If you have say £50,000 or other income, all of the lump sum would be taxable at 40% at least. This is why HappyHarry wanted to know about your other income, because that way it's possible to know whether you have any personal allowance to use for this pension payment and how much of the basic rate band remains unused.

steve1500

There will be another income of £25k dealt with under PAYE.


On the illustration I gave above, I know I will owe HMRC yet more at the end of the tax year.


Want to use the money to buy a property


If it is calculated they way I have outlined, then my plans are a goer

HappyHarry

If your total income next year is £25,000, then:

The first 25% of your pension pot, £12,500, is tax free.

The next £17,475 (£31785+10600-£25000) would be taxable at 20%,which would be £3,495 in tax.

The remaining £20,025 would be taxable at 40%, which wouldbe £8,010 in tax

So you would receive £38,495 and £11,505 would be taken intax.

Two points worth noting:
1. You are likely to pay emergency tax on taking your pension, and so will need to claim it back as jamesd says above.
2. You will pay 40% tax on £20,025 of your pension. Do you really, really want to do this?

steve1500

I know that at the end of the day the money in the pot will be combined with my salary.


That is why I have deducted a straight 20% & 40%.


I am working on the pension company deducting those figures no tax code etc.


Am I right? Then the tax man saying I owe them a few quid!!

jamesd

Ignoring the lump sum tax effects, you would have no personal allowance left and only £31,785 - (£25,000 - £10,600) = £17,385 of your basic rate band.

So for a £50,000 pot:

£12,500 would be the tax free lump sum leaving £37,500 taxable income.
£17,385 of that would be basic rate, so £3,477 income tax due, leaving £20,115 still untaxed.
That £20,115 would be taxable at higher rate, so £8,046 income tax due.

So you would have income tax due of £11,523 and a net received amount of £38,477.

But this ignores the special tax effects of taking a lump sum and having it taxed as though you're going to get the £37,500 of taxable income every month for the rest of the year. So until you file the form with HMRC to reclaim the extra tax you'd have less available.

HappyHarry

The pension company is most likely to work on the assumption that you will be taking £37,500 each month as taxable income, so will probably apply nearly a 45% tax rate to your taxable sum initially.

You can claim back the overpayment using form P53 (as jamesd details above), but you will likely need to wait a few weeks for a refund.

jamesd

The Prudential has a handy article about taxing. With no tax code the pension firm will use month 1 basis and the tax code 1060L M1. They will give you one twelfth of your personal allowance for the payment. So it will look like this:

£12,500 the tax free lump sum, leaves £37,500.
£883.33 tax free personal allowance, leaves £36,616.67.
Available basic rate band £31785/12 = £2,648.75
So £2,648.75 taxed at 20%, £529.75 income tax, leaves £33,967.92
Higher rate tax on the £33,967.92 = £13,587.17.

Total tax deducted £14,497.67.

This is more than the actual tax due of £11,523 so you'd be able to claim a refund of the £2,974.67 income tax overcharge.

The Prudential has an illustration for a £100,000 lump sum at the bottom of the page I linked to.

So before the tax reclaim you'd actually end up getting £12,500 + (£37,500 - £14,497.67) = £35,502.33.

This a fair way off the £36,400 you initially thought you might get, though of course after the tax refund you end up with more. The calculation is just a lot more fiddly!

atush

It is INSANE to take a pot of 50K in a lump sum, paying 40% tax on it, to buy a property (the income and gains from which ae taxed).

Sheer and utter madness.

If you want to be stupid and do it, take it over 2 years and pay only 20% tax on it

jem16

jamesd wrote: »

£12,500 the tax free lump sum, leaves £37,500.
£1,060 tax free personal allowance, leaves £36,440.

Tax free personal allowance of £10,600/12 = £883.33 not £1060.

So taxable amount is £36,616.67 which would give a total tax amount of £14,116.92.