How is tax taken on SIPP drawdown?

JohnB47

One family member has a small cash only SIPP that is in drawdown. They are unemployed/retired and are in receipt of the full State Pension - no other income. Since retiring from self employment, she has not completed a tax return (and is happy about that).

In the last two financial years, the drawdown amount has been chosen so as to avoid paying any tax - first £200 per month (2023-2024) then £90 per month (2024-2025). Next April, the amount would have to drop to around £49 per month to avoid tax. This is all because the Personal Tax Allowance has been frozen.

So we're wondering, if she decided to bite the bullet and withdraw enough per month that means she pays tax (20%), how would that be paid/taken? Would she have to volunteer a tax return?

We're also wondering if it's really worth continuing to contribute the yearly allowable £2880 (made up to £3600 by HMRC) to her other cash SIPP (not in drawdown), if eventually all withdrawals will be taxable.

I've done some sums and it seems that the return is 6.25% on money invested, assuming 25% is withdrawn tax free and the remainder is taxed at 20%. That still seems reasonable, although inflation will take it's toll - but that would happen anyway if the money was put in a regular savings account or ISA.

Any thoughts?

Marcon

JohnB47 said:

One family member has a small cash only SIPP that is in drawdown. They are unemployed/retired and are in receipt of the full State Pension - no other income. Since retiring from self employment, she has not completed a tax return (and is happy about that).

In the last two financial years, the drawdown amount has been chosen so as to avoid paying any tax - first £200 per month (2023-2024) then £90 per month (2024-2025). Next April, the amount would have to drop to around £49 per month to avoid tax. This is all because the Personal Tax Allowance has been frozen.

1. So we're wondering, if she decided to bite the bullet and withdraw enough per month that means she pays tax (20%), how would that be paid/taken? Would she have to volunteer a tax return?

2. We're also wondering if it's really worth continuing to contribute the yearly allowable £2880 (made up to £3600 by HMRC) to her other cash SIPP (not in drawdown), if eventually all withdrawals will be taxable.

I've done some sums and it seems that the return is 6.25% on money invested, assuming 25% is withdrawn tax free and the remainder is taxed at 20%. That still seems reasonable, although inflation will take it's toll - but that would happen anyway if the money was put in a regular savings account or ISA.

Any thoughts?

1. The SIPP provider will receive a (revised) tax code from HMRC in due course and tax will be taken that way - so no, unlikely she'll need to complete a full tax return, although HMRC might ask her to fill in the short version at some point.

2. 25% will be tax free, so only 75% will become taxable.

TadleyBaggie

The tax would be deducted by the SIPP provider based on the tax code they have been provided by HMRC. No different to any other type of income. There is no reason why a tax return would be needed.

QrizB

JohnB47 said:

I've done some sums and it seems that the return is 6.25% on money invested, assuming 25% is withdrawn tax free and the remainder is taxed at 20%. That still seems reasonable, although inflation will take it's toll - but that would happen anyway if the money was put in a regular savings account or ISA.
Any thoughts?

The SIPP should be invested in something appropriate (or even left in cash if your SIPP provider has a decent interest rate for cash holdings) so growth should be similar to regular savings interest. Hopefully you'll beat inflation and still be 6.25% ahead.

JohnB47

Thanks.

Good to think that a tax return could be avoided.

We must look at any interest the HR cash only SIPP gives - can't remember. It's just so tempting to invest £2880 to get £720 added each year, even if tax has to be paid.

molerat

JohnB47 said:

Thanks.

Good to think that a tax return could be avoided.

We must look at any interest the HR cash only SIPP gives - can't remember. It's just so tempting to invest £2880 to get £720 added each year, even if tax has to be paid.

Currently 3% minimum tiered and depending on what basis it is held

https://www.hl.co.uk/charges-and-interest-rates

bjorn_toby_wilde

Is there any particular reason, other than not wanting to complete a tax return, that she wants to avoid paying tax?

Also, why hold cash in the SIPP when the provider interest rates are so low?  A short term MMF is very low risk and beats the return on a savings account.

JohnB47

bjorn_toby_wilde said:

Is there any particular reason, other than not wanting to complete a tax return, that she wants to avoid paying tax?

Also, why hold cash in the SIPP when the provider interest rates are so low?  A short term MMF is very low risk and beats the return on a savings account.

Thanks.

"Is there any particular reason, other than not wanting to complete a tax return, that she wants to avoid paying tax?"

There is no reason for her to avoid paying 20% tax other than to save some money. Same as investing in an ISA rather than in a standard savings account, where there is a maximum interest that can be earned before tax is due.

She just thought that investing in a cash only SIPP and taking out the money without paying tax (for as long as her tax allowance would permit) would be intelligent investing. But then the allowance was frozen in 2021 and the grand master plan began to unravel.

bjorn_toby_wilde

JohnB47 said:

bjorn_toby_wilde said:

Is there any particular reason, other than not wanting to complete a tax return, that she wants to avoid paying tax?

Also, why hold cash in the SIPP when the provider interest rates are so low?  A short term MMF is very low risk and beats the return on a savings account.

Thanks.

"Is there any particular reason, other than not wanting to complete a tax return, that she wants to avoid paying tax?"

There is no reason for her to avoid paying 20% tax other than to save some money. Same as investing in an ISA rather than in a standard savings account, where there is a maximum interest that can be earned before tax is due.

She just thought that investing in a cash only SIPP and taking out the money without paying tax (for as long as her tax allowance would permit) would be intelligent investing. But then the allowance was frozen in 2021 and the grand master plan began to unravel.

I see. That makes sense. It’s just that when you said she had no other income I had this vision of somebody living very frugally just in order to avoid paying tax. Letting the tax tail wag the dog so to speak.

JohnB47

bjorn_toby_wilde said:

JohnB47 said:

bjorn_toby_wilde said:

Is there any particular reason, other than not wanting to complete a tax return, that she wants to avoid paying tax?

Also, why hold cash in the SIPP when the provider interest rates are so low?  A short term MMF is very low risk and beats the return on a savings account.

Thanks.

"Is there any particular reason, other than not wanting to complete a tax return, that she wants to avoid paying tax?"

There is no reason for her to avoid paying 20% tax other than to save some money. Same as investing in an ISA rather than in a standard savings account, where there is a maximum interest that can be earned before tax is due.

She just thought that investing in a cash only SIPP and taking out the money without paying tax (for as long as her tax allowance would permit) would be intelligent investing. But then the allowance was frozen in 2021 and the grand master plan began to unravel.

I see. That makes sense. It’s just that when you said she had no other income I had this vision of somebody living very frugally just in order to avoid paying tax. Letting the tax tail wag the dog so to speak.

Yes I see now. Your post seemed odd to me, as mine did to you! She is adequately supported by a partners income (all taxed). It's just that a SIPP idea came along a few years ago and without a career pension built up, it seemed too good to pass up. Thanks.