Tax-free Lump Sum - what's the catch?

KevinG

Let's assume that I have a pension pot of £800,000 on retirement. At an annuity rate of 5% (say), this would give me an income of £40,000 which would be taxed at 20%, i.e. £8,000 pa. (I am ignoring the personal allowance which may or may not have been used up by other income). Now, assume I take the 25% tax-free lump sum of £200,000 leaving a pension pot of £600,000 which, at an annuity rate of 5% would give an income of £30,000 and a tax of £6,000 pa. Is this right or would I be liable to more tax on the remaining pot because I had taken £200,000 tax-free? The lower amount, combined with my state pension, would be more than enough for me so why wouldn't I take the lump sum? Is there a catch?

Thanks.

Mnd

I think you are correct in your assumptions

Albermarle

There is no catch as such . The ability to take a 25% lump sum tax free is there because overall it makes saving into a pension more attractive . For example if there was no TFLS and you were a basic rate taxpayer, both whilst paying in to a pension and then later taking an income from it , then would be no tax advantage to saving into a pension.

squirrelpie

There's no catch, if you have a use for the £200,000. If not, it brings the money into your estate where it may be caught by inheritance tax, whereas it isn't if left in the pension.


Note that you first example calculation wouldn't want to ignore the personal allowance, especially if the other income was a state pension, because it would take you into higher rate tax. I appreciate it was just a quick and dirty calculation but redo it for real before using it.

dunstonh

At an annuity rate of 5% (say), this would give me an income of £40,000 which would be taxed at 20%,

You wouldnt buy an annuity on the full value. That would likely be a missale (if under advice or misbuy if non-advised) unless there was a GAR.

With annuity purchase, you normally take the maximum tax free cash entltlement.

Is there a catch?

No catch.

With drawdown, rather than annuity, the situation may well be different (and on advised cases, it usually is. on non-advised cases less so but that is more to do with DIY people not knowing all the options).

KevinG

squirrelpie wrote: »

Note that you first example calculation wouldn't want to ignore the personal allowance, especially if the other income was a state pension, because it would take you into higher rate tax.

Another good reason for taking the TFLS!

KevinG

Albermarle wrote: »

There is no catch as such . The ability to take a 25% lump sum tax free is there because overall it makes saving into a pension more attractive . For example if there was no TFLS and you were a basic rate taxpayer, both whilst paying in to a pension and then later taking an income from it , then would be no tax advantage to saving into a pension.

Indeed, but I would guess that a lot of people don't take the TFLS and thus lose that benefit for the sake of higher (potentially taxed) income.

dunstonh

KevinG wrote: »

Indeed, but I would guess that a lot of people don't take the TFLS and thus lose that benefit for the sake of higher (potentially taxed) income.

Not taking the TFC is virtually unheard of with annuities unless it is a GAR.

Not taking it with drawdown on the hand is quite normal and usually more tax efficient (although on pure numbers, taking the 25% up front is still most common)