The tax added back on lump sum payments into a pension

CREDWIN

Just so you know the background, I'm 67 years old, and work on a self-employed basis. I have a good level of savings currently in ISA's and fixed term bonds, and am drawing my State Pension.  I intend to purchase an annuity from my private pension pot of around £130K either later this year or next year.
 I have around £10K generated from my self-employed business which I was considering putting into a cash ISA, but having already paid the tax on this amount through my 2020-21 account, it occurred to me that if I put the10K into my pension, the tax will be added back, making the sum £12,500. I don't think that's controversial. What I would like to know is, as I may purchase the annuity this year, and can take a max of 25% of the pot tax-free, is there anything stopping me taking that £10K back out at that time, at which point, it will have become £12,500? It seems too easy a loophole to exploit if that's the case. I know I can pay into the pension, up to 100% of my self-employed earnings for the year, so why wouldn't I do that, knowing I can take the sum out again with the tax added back, when I purchase the annuity? Hope I explained that properly!

AlanP_2

No reason why you shouldn't at all. It's no different to someone on a PAYE scheme contributing to their workplace pension in the year before they retire and access the pot.

BTW - You can continue addinbg to a pension until Age 75 so you could continue with that stratgey.

Dazed_and_C0nfused

Not everyone can afford to put most of their earnings into a pension.

You cannot do exactly what you have said.

I have around £10K generated from my self-employed business which I was considering putting into a cash ISA, but having already paid the tax on this amount through my 2020-21 account, it occurred to me that if I put the10K into my pension, the tax will be added back, making the sum £12,500

Assuming you are a sole trader and the £10k is your expected profit for 2020:21 then you can contribute £10k gross to a relief at source pension such as a SIPP.

The £10k contribution would consist of £8k from you and £2k added by the pension company.

If you actually paid £10k then it would be a gross contribution of £12.5k, more than you have earned.

Albermarle

I think you are thinking the tax gain is more than it is ?
You have a pension pot now of £130K . If you took the 25% tax free now it would be £32.5K and £97.5 K as a taxable annuity .
If instead you now add £8k + £2K tax relief you will have £140K . Now you can take £35K tax free and £105K as a taxable annuity .
So although you gained £2K tax relief on the way in , you will also now pay more tax ( £1.5K) on the way out , so your actual tax gain is £500 .

CREDWIN

Thank you all for your fast replies. It's difficult to describe in writing what my actual plan is, so I tried to keep it simple in round sums so my brain would understand your answers better. It all sounds good.
Alan - The suggestion about adding to the pot until I reach age 75, has me wondering. I guess once I purchase the annuity, I can't do that - it's only while it's a pension pot (so to speak) Is that right?

Dazed - thank you for the clarification about the amounts I can put in. The expected profit is a few multiples of the £10K, but I get the point about remembering that the tax added back counts towards the max allowed in the tax year. 

Albemarle, thank you too for the illustration. I know when you reply to queries, you try to add nuances to cover everything the poster might be thinking. In my case, I was always going to take the whole £130K as an annuity. It just occured to me that this simple transaction would add back the tax I was going to lose on the lump sum, by taking it back tax-free when I buy the annuity. Still sounds too good to be true haha, but I guess pop stars and ex-footballers will make more use of it than I will. 

AlanP_2

Once you convert this pot to an annuity you can't add to it but you can open another pension account and contribute to that each year up until age 75. Even if you have no earned income you can contribute £2880 net / £3600 gross per year.

That can then be withdrawn at an effective tax rate of 15% for a BR taxpayer, resulting in a "profit" of £180 or 6.25%, or left to build up when it could be used for another annuity if that is what you wanted.

CREDWIN

Thanks Alan. That's great advice as I don't know how long  I will continue my self-employment business. 
Best wishes
David