25% tax free sum at 55 from drawdown

Ella_fella

Apologies if this has been covered elsewhere, I am a couple of years from being allowed to access my pension pot where I understand the rules are I can access upto 25% of these monies tax free. 

A couple of questions around this, if I withdraw 25% tax free this will this be though classified as earnings so then will be liable to some tax further on down the line?

If I pay say 40k net into my pension scheme this will be in effect 48k gross with the government paying the 20% so if I withdraw it I will be getting an extra 8k for "free"?

And what happens to the rest of my money residual in my pension scheme - will this be now liable for tax if I choose to use it as an income later on? Or are all pension earnings taxable outside of this 25% lump sum?

Thanks in advance 

DavidT67

Pension Commencement Lump Sum is exactly what it says, Tax Free, no income tax due.

However if you take a quarter of your entire pension pot upfront, that then means every subsequent withdrawal will be taxable income.

Depending on your other income sources, such as state pension, defined benefit annuities, etc. it might be smarter to stagger the TFLS over a number of years, using something called UFPLS.

DebtSurfer

Hi I am in about the same situation, only I'm turning 55 in Sep '23.
I am not an expert, and actually am trying to figure out the best ways to deal with my sizable pension pot.

My understanding is this (correct me if I'm wrong).

If you take 25% tax-free lump sum, 
-- Your 25% tax free lump sum is NOT taxed in any way.
-- However regarding whatever money is left in your pot (pots), whatever you will be withdrawing after that, will be fully taxable (added to earnings if you continue to work). 

If you didn't take 25% tax-free lump sum and started the drawdown, 
-- 25% of what you take will be tax-free
-- and 75% taxed.

Also my understanding is, once you have started using your pension pot, your annual tax-free pension contribution allowance of £40,000 is changed to £4,000 (I think there is some movement that could become £10,000 actually) to prevent "pension recycling". Which makes the snapshot on the 25% pot size value, and limits your abilities to top up your pension pot.

If you were to wait longer before dipping into your pension pot, your pot size could be higher and so would be the 25% tax-free lump sum.

=================

About the changing tax regime:

-- Let's say later during my retirement, I want to withdraw £26k at year X, and £13k is HMRC untaxed allowance for that year.
Then
1 -- If I DID NOT take that 25% tax-free lump sum,
I'd be getting £6.5k tax-free and £19.5k taxable, of which £13k would be untaxed allowance and £6.5k will be taxed at 20% -- tax loss is £1.3k
2 -- If I DID take that 25% tax-free lump sum earlier,
I'd be getting all £26k taxable, of which £13k would be untaxed allowance and £13k would be taxed at 20% -- tax loss is £2.6k

In my case (1) I'd withdraw £26000 from my pension pot and get £24700 net.
In my case (2) I'd withdraw £26000 from my pension pot but get £23400 net -- additional losses £1300.

Bimbly

You may take the 25% tax free.

The remaining 75% will be taxable whenever you take it.

So, here's the catch - and the reason why the general advice is not to take it from your pension until you retire unless you really have a good reason - the remaining 75% stays invested and is likely to grow. So now you're liable for tax on the whole lot, including the investment increase. Over ten years (to 65), that could be a big chunk of extra tax.

As referred to above, if you take even a penny of the taxable amount, this triggers the MPAA which curtails your ability to pay into a pension to £10,000 per year (from April, currently £4,000/year) and you probably don't want to do that.

Ella_fella

DavidT67 said:

Pension Commencement Lump Sum is exactly what it says, Tax Free, no income tax due.

However if you take a quarter of your entire pension pot upfront, that then means every subsequent withdrawal will be taxable income.

Depending on your other income sources, such as state pension, defined benefit annuities, etc. it might be smarter to stagger the TFLS over a number of years, using something called UFPLS.

So if I make a lump sum of say £20k into my SIPP will this then show up as £24k in my account (20% tax relief?)

xylophone

If I pay say 40k net into my pension scheme this will be in effect 48k gross with the government paying the 20% so if I withdraw it I will be getting an extra 8k for "free"?

 Have you considered Annual Allowance in the current tax year?

https://www.gov.uk/tax-on-your-private-pension/annual-allowance

If you are in a "relief at source" scheme" (and assuming that you earn at least £40,000 in the tax year you propose making the contribution) you would contribute £32.000 to the pension and the provider would claim TR of £8000 and add it to your pension.

https://www.litrg.org.uk/latest-news/news/181214-do-you-understand-how-tax-relief-your-pension-contributions-works

Carry Forward  ( which could permit a contribution in excess of AA) might be a possibility under certain circumstances.

https://www.moneyhelper.org.uk/en/pensions-and-retirement/tax-and-pensions/carry-forward#:~:text=Carry forward allows you to,still benefit from tax relief.

Changes in the March Budget  (increase in AA).

https://kpmg.com/uk/en/home/insights/2023/03/tmd-budget-changes-to-pension-savings-limits.html

Pipthecat

1 -- If I DID NOT take that 25% tax-free lump sum,

2 -- If I DID take that 25% tax-free lump sum earlier,

In my case (1) I'd withdraw £26000 from my pension pot and get £24700 net.
In my case (2) I'd withdraw £26000 from my pension pot but get £23400 net -- additional losses £1300.

Obvious point, but option 2 assumes you took and spent the 25% i.e. you did not save it to supplement your income  

DebtSurfer

Pipthecat said:

1 -- If I DID NOT take that 25% tax-free lump sum,

2 -- If I DID take that 25% tax-free lump sum earlier,

In my case (1) I'd withdraw £26000 from my pension pot and get £24700 net.
In my case (2) I'd withdraw £26000 from my pension pot but get £23400 net -- additional losses £1300.

Obvious point, but option 2 assumes you took and spent the 25% i.e. you did not save it to supplement your income  

Yeah.
Which is just makes things worse for one's later life.
Money spent now and not available later is one part of affliction, but even those money they will withdraw later, will have lesser contribution on their real income.

23400/24700 is a loss of only about 5% of net income, but here's the rub. The bills take fixed sum of income, not fixed part of income. Thus the disposable income left will deteriorate more in percent sense...

Let's assume the mortgage is paid, the car is paid off and still going strong.

Monthly income from taking £26k from pension pot a year, is £2060 and £1950 correspondingly in our two cases.
Monthly utility bills are £550 (energy, water, council tax, internet/mobile, we kicked the TV licence b/c who the hake watches BBC?!)
Another £400 for family groceries.
£150 for two cars diesel.
Annual bills for car insurance, car MOT, car tax, car service, two cars. Another £1800 or £150 per month.

So even without unexpected bills now, the fixed expenses are £1250 per month, leaving:
Disposable income of £810 in first case and £700 in second case. The Delta is already nearly minus 15%.

And since we took 25% of lump sum then... it won't last as long. E.g. instead of 24 years, only 18 years. Of 15% lesser income.

That's the real cost of indulging and taking that lump sum.

Granted, there are cases where it may be beneficial. Heavy debts which are not growing, for example. Interest will drink the blood out of those who continue to have debts. Lump sum can pay it off and start from the clean plate, saving countless thousands in the interest over years. Not to mention instant boost to mental health due to not having debts anymore...

DavidT67

Ella_fella said:

So if I make a lump sum of say £20k into my SIPP will this then show up as £24k in my account (20% tax relief?)

If you personally contribute £20K from Net income to a pension the tax relief uplift to your pension is 25%, i.e. £5K.

That's equivalent to the 20% income tax on £25K Gross income.

Grumpy_chap

Is it an either/or take 25% tfls or take 25% tax free each year?

Is it possible, say, to take 10% lump sum and then 15% tax free each year?

tetrarch

The only massive assumption here is that the TFLS stays forever. There is no guarantee that a future Labour (or cash-strapped Tory) Government will reduce, or eliminate it.

I took every penny of my TFLS as soon as I could after I retired (early), but I reinvested it as soon as I could inside my and my Wife's ISA allowances to make it truly tax free in the future.

Regards

Tet