Drawdown and Tax

Curious_Moose

If you take 25% of your SIPP fund as tax free cash after 55, the remainder can be used to generate an income in drawdown. It's my understanding that the drawdown provider will deduct tax from this. However, what happens if the total amount withdrawn each year is under the personal allowance and any other income is generated from an ISA which is tax free anyway. Can you reclaim the tax deducted back from HMRC and how would you go about doing this? I.e. is there a form that you fill in for HMRC, or you have to notify the drawdown provider so they don't deduct tax in the first place? Can you only do this at the end of each tax year or can you effectively say to HMRC "I'm withdrawing less than my personal allowance so tell the drawdown provider they don't need to deduct tax". What, in practical terms, would actually need to be done?


Many thanks.

Linton

Drawdown is taxed by PAYE in exactly the same way as wages using a taxcode supplied by HMRC. The first drawdown ever after the tax free 25% will be taxed as if the same amount was going to be taken for each of 12 months. Obviously this could lead to a high deduction. You can claim the excess tax back before the end of the tax year by using a form from here. By the time the next drawdown is taken HMRC will have issued a new tax code and things will sort themselves out.

There is no way around this problem as it is a feature of PAYE which wasnt designed for one-off payments. But it will only ever happen once. The pension provider has no freedom of action - they must follow the HMRC instructions and HMRC cant do anything different because they dont know the pension provider exists as your "employer" until the first payment is recorded.

Curious_Moose

Linton wrote: »

Drawdown is taxed by PAYE in exactly the same way as wages using a taxcode supplied by HMRC. The first drawdown ever after the tax free 25% will be taxed as if the same amount was going to be taken for each of 12 months. Obviously this could lead to a high deduction. You can claim the excess tax back before the end of the tax year by using a form from here. By the time the next drawdown is taken HMRC will have issued a new tax code and things will sort themselves out.

There is no way around this problem as it is a feature of PAYE which wasnt designed for one-off payments. But it will only ever happen once. The pension provider has no freedom of action - they must follow the HMRC instructions and HMRC cant do anything different because they dont know the pension provider exists as your "employer" until the first payment is recorded.

Thanks for that. So in practical terms would it be something like this:
1) You take 25% tax free cash. No tax is deducted.
2) You take £500 income from the SIPP each month. The provider deducts 20% = £100 so only £400 goes into your bank account.
3) At the end of the tax year, you fill in a form for HMRC to the effect "I've taken £6,000 from the SIPP and paid £1,200 of this in tax. This is below my personal tax allowance so I am claiming back £1,200 in overpaid tax"
4) HMRC send a cheque for £1,200


Or would it be:
1) You take 25% tax free cash. No tax is deducted.
2) You take £500 income from the SIPP each month. This multiplied by 12 is only £6,000 which is below your tax code allowance, so the provider wouldn't deduct any tax and you get £500 in your bank account.
3) HMRC don't need to be informed.






Thanks

Linton

If my understanding of PAYE is correct, neither...

Assuming you are taking a monthly drawdown....

1) You take 25%, no tax deducted
2) Tax Month n: You take your first £500, £100 is deducted
3) Tax Month n+1: Assuming you have no other income HMRC issue a tax code of say 1100 for an available personal allowance of £11000 so when you take your £500 you also get your £100 back.
4) Tax Month n+2: No tax deducted. You get £500

If n=12 you will have to wait for HMRC to calculate that they owe you £100 or you phone them and ask for it. Unless n=12 you never need to contact HMRC.

I personally take a single annual drawdown at the end of the tax year to get as much as I can but keep within my current tax band. Money which isnt needed for the next 12 months goes into an S&S ISA.

Curious_Moose

Linton wrote: »

If my understanding of PAYE is correct, neither...

Assuming you are taking a monthly drawdown....

1) You take 25%, no tax deducted
2) Tax Month n: You take your first £500, £100 is deducted
3) Tax Month n+1: Assuming you have no other income HMRC issue a tax code of say 1100 for an available personal allowance of £11000 so when you take your £500 you also get your £100 back.
4) Tax Month n+2: No tax deducted. You get £500

If n=12 you will have to wait for HMRC to calculate that they owe you £100 or you phone them and ask for it. Unless n=12 you never need to contact HMRC.

I personally take a single annual drawdown at the end of the tax year to get as much as I can but keep within my current tax band. Money which isnt needed for the next 12 months goes into an S&S ISA.

Thanks very much. That's a big help.

ManAtHome

Going back a few years now, but pretty sure I just sent my provider (Hargreaves Lansdown) my P45 and they sorted the (lack of) tax.

As stated above, if you take a one-off payment at the start of the tax year, you'll be taxed as if it's a monthly payment. Taking £500 a month won't be taxed - you should be able to draw up to around £900pm this coming tax year.