Lump Sum from deferred pension

awaw76

So we have got my wife state pension through which was deferred for 10 years. We have been given the option of a lump sum or extra pension. I have three questions - 
1)How do I know they have worked the lump sum out correctly
2) Is it better to take the lump sum or extra weekly pension?
3) If we take the lump sum - what are the tax implications. My understanding is that as my wife does not work or have any other income apart from her state pension then the lump sum will be paid tax free? Her state pension is £73. 

calcotti

1) Here is the information on how the lump sum is calculated https://www.gov.uk/deferring-state-pension/what-you-get (although I'm not sure it helps much!).

2) You need to think about your joint circumstances. Use a benefits calculator to see if you are entitled to any means tested benefits. If you are then taking extra pension doesn't benefit you because the extra pension will simply reduce the means tested benefits so the lump sum would possibly make sense. Although even then you have to factor in that the benefits system may change so you might consider the extra pension more reliable. 
If means tested benefits are not a consideration it's more a case of deciding whether a lump sum or increased income is likely to be more useful. You might wish to also factor in how many years of extra pension it will take to get the same amount of money back as the lump sum and then weigh that against whether your wife is healthy and could live a long time or is unwell and not expecting to live long (which I hope isn't the case).

3) For tax it says "You’ll be taxed at your current rate on your lump sum payment. For example, if you’re a basic rate taxpayer your lump sum will be taxed at 20%.". I think this means that if the lump sum plus the annual pension goes over £12,500 the excess will be taxed at 20%.

There is no right or wrong answer. It depends on your circumstances and what matters to you. If you need to do something which needs capital expenditure which you haven't got then the lump sum may enable you to do whatever it is.

See also https://www.which.co.uk/money/pensions-and-retirement/state-pension/deferring-your-state-pension-ahr9w8p0f87w#:~:text=Do%20I%20pay%20tax%20on%20deferred%20state%20pension%3F,tax%20rate%20because%20you%20received%20a%20lump%20sum.

awaw76

Thats what I don't understand - my wife isn't a basic rate tax payer as she will be on £3500 per year which is below the threshold, so is she a zero rate tax payer?

xylophone

See https://www.litrg.org.uk/tax-guides/pensioners/what-tax-do-i-pay-my-state-pension-lump-sum

calcotti

awaw76 said:

Thats what I don't understand - my wife isn't a basic rate tax payer as she will be on £3500 per year which is below the threshold, so is she a zero rate tax payer?

I don’t think so. There is a tax free allowance on which no tax is collected but the applicable tax rate is 20% not zero. On that basis I think she is a 20% rate tax payer. 
What income has she had up to now anyway?
incorrect - put right by dazed_and_confused below.

Dazed_and_C0nfused

If her total taxable income in the tax year she gets the lump sum, including the weekly/4 weekly State Pension she is entitled to from when it starts being paid, is only £3,500 then there would be no tax payable on the State Pension Lump Sum.

calcotti

Dazed_and_C0nfused said:

If her total taxable income in the tax year she gets the lump sum, including the weekly/4 weekly State Pension she is entitled to from when it starts being paid, is only £3,500 then there would be no tax payable on the State Pension Lump Sum.

Can you reference or explain that further that?

Dazed_and_C0nfused

See example "Jane" in this guide from LITRG.  But ignore deferral for another year.

https://www.litrg.org.uk/tax-guides/pensioners/what-tax-do-i-pay-my-state-pension-lump-sum

calcotti

Dazed_and_C0nfused said:

See example "Jane" in this guide from LITRG.  But ignore deferral for another year.

https://www.litrg.org.uk/tax-guides/pensioners/what-tax-do-i-pay-my-state-pension-lump-sum

That’s clear. Thanks for clarifying and highlighting.

awaw76

Dazed_and_C0nfused said:

If her total taxable income in the tax year she gets the lump sum, including the weekly/4 weekly State Pension she is entitled to from when it starts being paid, is only £3,500 then there would be no tax payable on the State Pension Lump Sum.

To clarify - the tax on the lump sum is paid on whatever the current rate you are on. So as my wife is below the 12500 threshold then there would be no tax to pay on the lump sum - even if that lump sum pushed her into the higher tax bracket. 
The lump sum is just over £23k. 

Dazed_and_C0nfused

It isn't quite that simple - for example if she was say liable to one of the 0% tax rates on savings income then she would have to pay basic rate tax on the lump sum even though she may not actually be a "taxpayer" in the normal sense.

You do not include the State Pension Lump sum when calculating her tax rate.

Don't forget though that her Personal Allowance may only be £11,250 and you must include the normal State Pension payments when calculating her taxable income.