Pensions Cash Withdrawl Tax

m178591

I wonder whether anyone can clarify the situation around taking pension funds as drawdown and the effect of the 25% tax free lump sum and the annual personal allowance before income tax is paid. Let’s assume I have a pension pot of say £50000 and no other sources of taxable income in said financial year. If I withdraw all of my pension pot in one lump sum it seems I can take 25% tax free and the remainder is taxed at 25%. That means £12500 tax free and then tax at 25% on the remainder which would be 25% of 37500 which would be a tax bill of 9375. What I want to know is how my annual personal allowance of £12500 would figure in this. Once I’ve taken my 25% tax free chunk from my pension is the rest taxed at 25% or could I then deduct my personal allowance from the remaining balance before paying tax on the what’s left.

Dazed_and_C0nfused

Where are you getting a tax rate of 25% from?

The TFLS is exactly what it says and as is irrelevant for tax purposes.

That leaves you with £37,500 of taxable income.

£12,500 will be covered by your Personal Allowance (of £11,250 if you have applied for Marriage Allowance).

The remaining £25,000 will be taxed at one or more of the 19%, 20% and 21% tax rates.

The exact rate will depend on where you are resident for tax purposes in the tax year you have the taxable pension income.

m178591

Thanks.

I read something about the 25% tax rate somewhere but just having a quick look I can’t find anything about it again.

So, in principle £50000

Year 1

£12500 tax free lump sum

£12500 tax free personal allowance

So £25000 taxes and no tax due

Year 2

£12500 tax free personal allowance so no tax due

Year 3

£12500 tax free personal allowance so no tax due

thus meaning I’ve taken all of this pension pot without paying any income tax. Is this correct?

DairyQueen

In the scenario that you describe, and as you state, the first 25% of the withdrawal would be tax free. The remaining 75% would be added to any other taxable income you receive in the same tax year and would be taxed accordingly. Absent any other taxable income your personal allowance would be allocated entirely to the taxable element of the withdrawal. The sums would look like this:

25% tax free cash = £12,500
Taxable balance = £37,500
Deduct personal allowance of £12,500
Taxable at 20% on balance of £25,000
Tax due = £5,000.

However, and assuming that you had no other taxable income in two tax years, then you could drawdown the 25% tax free cash in tax year 1 and split drawdown of the £37,500 balance across tax years 1 and 2. This would save you a chunk of tax:

Tax year 1:
a) Take 25% tax free cash on entire £50,000
b) Drawdown half of the £37,500 balance (all taxable) = £18,750
c) Deduct personal allowance of £12,500 
d) Balance taxable at 20% = £6,750
e) Tax due = £1,350

Repeat steps b) thru e) in tax year two.

Total tax payable across two tax years = £2,700

Note that taking one penny of taxable cash from your pension will trigger the MPAA and this will limit any future pension contributions to £4,000p.a.

m178591

So so it would be possible with careful planning to take the entire pot tax free as income drawdown over a number of years as long as I never exceed my £12500 personal tax allowance. A bigger pot would just last longer in this scenario but still no tax paid, assuming all my assumptions remain valid.

DairyQueen

m178591 said:

So so it would be possible with careful planning to take the entire pot tax free as income drawdown over a number of years as long as I never exceed my £12500 personal tax allowance. A bigger pot would just last longer in this scenario but still no tax paid, assuming all my assumptions remain valid.

Yes, exactly so. Absent any other taxable income, and by splitting withdrawals across several tax years, you could take it all free of tax

m178591

Thanks all. That’s clarified things for me.

Dazed_and_C0nfused

In reality you may have some additional taxable income - interest received from banks etc.

In the scenario you outlined where your only other taxable income is £12,500 pension income then the first £6,000 of interest would all be taxed at 0%.

AlanP_2

An alternative, also tax free, would be to take £12,500 taxable each year + the 25% tax free element associated with that £12.5k.

If you withdrew £16,666.67 each year then 25% of that would be tax free (£4166.67) and the remainder (£12,500) taxable but within your annual allowance.

Over 3 years you end up in the same place on your £50k example pot but provides a level income over the period.

JohnB47

AlanP_2 said:

An alternative, also tax free, wopuld be to take £12,500 taxable each year + the 25% tax free element associated with that £12.5k.

If you withdrew £16,666.67 each year then 25% of that would be tax free (£4166.67) and the remainder (£12,500) taxable but within your annual alloweance.

Over 3 years you end up in the same place on your £50k example pot but provides a level income over the period.

That's interesting. I thought you had only one chance to take 25% of the pot tax free. But you're saying you can take a chunk out in more than one year and 25% of each chunk is considered tax free. Is that correct? 

AlanP_2

JohnB47 said:

AlanP_2 said:

An alternative, also tax free, wopuld be to take £12,500 taxable each year + the 25% tax free element associated with that £12.5k.

If you withdrew £16,666.67 each year then 25% of that would be tax free (£4166.67) and the remainder (£12,500) taxable but within your annual alloweance.

Over 3 years you end up in the same place on your £50k example pot but provides a level income over the period.

That's interesting. I thought you had only one chance to take 25% of the pot tax free. But you're saying you can take a chunk out in more than one year and 25% of each chunk is considered tax free. Is that correct? 

Yes, 25% of each chunk is tax free. Not all pensions / providers can support this from what I've seen commented on here (usually older schemes with older IT systems) so you may need to transfer it to a provider / pension that can support it.