Pension income tax rate and tax-free lump sum

eegg7777

I am about to retire. I would like to buy an annuity with 100% of my pension pot. That is, I don't intend to take the 25% tax free lump sum. How is income tax calculated in that case? Does HMRC take into account that 25% of the capital that bought the annuity is tax free (and reduce the tax rate accordingly)?

If the answer to the above is NO (the rate of income tax is the same regardless of taking the tax-free lump sum or not), would this be a better option:

1) Take the 25% tax-free lump sum and buy an annuity with the remaining 75%. This will be subject to the usual rate of income tax.

2) Get a PURCHASED ANNUITY with the 25%. My understanding is that purchased annuities are taxed at a lower rate, because part of the annuity income is considered capital repayment.

Should I do the above, or it happens automatically “under the covers” when one doesn’t take the tax-free lump sum?

Thanks!

Marcon

eegg7777 said:

I am about to retire. I would like to buy an annuity with 100% of my pension pot. That is, I don't intend to take the 25% tax free lump sum. How is income tax calculated in that case? Does HMRC take into account that 25% of the capital that bought the annuity is tax free (and reduce the tax rate accordingly)?

If the answer to the above is NO (the rate of income tax is the same regardless of taking the tax-free lump sum or not), would this be a better option:

1) Take the 25% tax-free lump sum and buy an annuity with the remaining 75%. This will be subject to the usual rate of income tax.

2) Get a PURCHASED ANNUITY with the 25%. My understanding is that purchased annuities are taxed at a lower rate, because part of the annuity income is considered capital repayment.

Should I do the above, or it happens automatically “under the covers” when one doesn’t take the tax-free lump sum?

Thanks!

If you don't take any tax free cash and use the whole of your pension pot to buy an annuity, then the whole of your annuity is taxed at your marginal rate.

If you take 25% tax free cash and buy a 'non-pension' annuity, you are correct - part of that is treated as a return of capital and so your overall tax bill will be lower.

Get some quotes and see which gives you the better outcome. An IFA will often be able to get better rates, so worth considering that route.

xylophone

If you wish to consider taking financial advice, you could try

https://adviserbook.co.uk/

You would tick "confirmed independent" and specialisms required when the menu comes up.

You would then ring round to discuss fees/ requirements etc.

Albermarle

) Get a PURCHASED ANNUITY with the 25%. My understanding is that purchased annuities are taxed at a lower rate, because part of the annuity income is considered capital repayment.

It seems that very few people buy purchased annuities, so it is a niche market and not as competitive as the main pension annuities market. So you can expect to get a poorer income offered , maybe with less options available.

With 75% of your pension already used for an annuity, it may be a good idea to invest the 25%, to bring some balance/flexibility. Possibly via a new pension. 

dunstonh

I would like to buy an annuity with 100% of my pension pot. That is, I don't intend to take the 25% tax free lump sum. 

In most cases, that would be considered bad advice.    There would need to be justification for using the 25% tax free in exchange for a taxable income.     The only real scenario where it is justifiable is if there is a GAR, that net of tax, is higher than that of a purchased life annuity.

How is income tax calculated in that case? Does HMRC take into account that 25% of the capital that bought the annuity is tax free (and reduce the tax rate accordingly)?

Its taxable as there ceases to be any 25% TFC.

1) Take the 25% tax-free lump sum and buy an annuity with the remaining 75%. This will be subject to the usual rate of income tax.

That is the normal way.

2) Get a PURCHASED ANNUITY with the 25%. My understanding is that purchased annuities are taxed at a lower rate, because part of the annuity income is considered capital repayment.

Not many do that as the commercial terms are not normally worth it but it is an option.

Should I do the above, or it happens automatically “under the covers” when one doesn’t take the tax-free lump sum?

Buying an annuity is normally best via an IFA.   So, what does your adviser say?