Why do I pay tax on my AVC lump sum?

Cunnidc1

I'm have a defined benefit pension and have also built-up AVCs (known as APeCS by my pension provider).

I'm about to retire and have two options: 1. take my full pension as an income, or 2. take a reduced pension and a tax-free lump sum. In option 1, only 25% of my AVC lump sum is tax free. In option 2, the whole amount is tax-free. 

I'm struggling to understand why the AVC lump sum is treated differently between #1 and #2.

The value of the AVCs is not huge and will not effect my decision to take #1 but I would like to understand a little more, so if anyone can help it'd be appreciated. Cheers

dunstonh

I'm struggling to understand why the AVC lump sum is treated differently between #1 and #2.

The rules allow the PCLS entitlement to be diverted to other pensions.  It is rarely used on individual pensions as it would be very complicated.    However, it is often used with in-house AVCs.    

So, they can transfer the PCLS entitlement over to the AVC which will allow a greater amount of tax free cash  (possibly on the whole balance of the AVC), and not reduce the income as much.

Option 2 would be the best option in most cases.

xylophone

Natwest DB?

https://epa.towerswatson.com/accounts/NW1/public/natwest-group-pension-fund-benefits/

When you come to take your benefits, you’ll have options:

• You can choose to take your benefits any time from age 55.
• You can choose to take a tax-free cash lump sum upfront (up to a certain amount), but this will reduce your annual pension.
• You can choose to take any Additional Pension Contributions (APeCs) you’ve made as a pension, as part of your tax-free lump sum, or to invest them in a drawdown account and withdraw from them as and when you need.

If you chose the drawdown option for APeCS, (in effect a separate DC pension) you would be able to take 25% tax free with the balance taxed as income in the year of receipt.

You would also be able either to take the DB in full without reduction (all taxable income) or commute part of it to create a tax free PCLS with reduced (taxable) monthly pension.

If the APeCs are taken with the DB, it enables you to  take them as part of the tax free PCLS so leaving a higher monthly pension than you would otherwise have had after commutation.