Deferred State Pension - Tax break?

oxters

My OH will qualify for state pension later this year. She has a very part-time job but if she takes the pension she will pay some tax as her income will rise above the threshold for paying tax.

However.......... if she defers the pension it will accrue interest at Circa 2% above the BoE rate and when she eventually takes the lump sum built up, it will be tax free.

Or that's the info I get when I phone the tax office and at least part of that is confirmed in the book you get from the pension office.

We get a detailed book on "deferred pension" soon so I should be able to confirm the above.

In the meantime, this looks like a win - win situation as the money is safe and goes into the estate if you pop your clogs suddenly.

Mikeyorks

oxters wrote: »

... and when she eventually takes the lump sum built up, it will be tax free.

Or that's the info I get when I phone the tax office and at least part of that is confirmed in the book you get from the pension office.

I'm afraid the Pension Service site doesn't agree with you on that. The lump sum is clearly categorised as taxable?

http://www.thepensionservice.gov.uk/statepensiondeferral/home.asp

BUT : only at the marginal rate paid. As the lump sum is not aggregated with other income. Fairly well explained here? :

http://www.hmrc.gov.uk/manuals/eimanual/EIM74651.htm

This is the particularly relevant bit :

These rules mean that whilst any state pension lump sum is charged to Income Tax it will not be aggregated with the individual's other income and consequently it cannot push the individual into a higher tax band. Neither can it affect the amount of any age-related personal allowance or married couple's allowance that might be due.

Instead any state pension lump sum is taxed at the highest rate of tax that applies on the individual's total income. This highest rate is the one that applies after the set-off of all reliefs and allowances that are deducted in 'arriving at' and 'from' total income. This rate of tax is commonly referred to as the individual's "marginal rate".

millie

I have done the same thing and deferred my state pension for the last year. I am about to claim it from the new tax year. My understanding of the lump sum issue is that as long as my other taxable income for the year that I claim the lump sum in falls below the tax threshold, £5435 for the 2008/2009 year the lump sum is not taxable. If I go above the threshold the lump sum is taxed at the level of my other taxable income. I do not need to claim the lump sum immeadiately, so I could wait until a year that my income is going to be less. I think I have 2 years to claim it.

Mikeyorks

Agree with your summary (but don't have a clue re the 2 year period)

Importantly the lump sum also does not impact on any age related personal allowances

oxters

millie wrote: »

I have done the same thing and deferred my state pension for the last year. I am about to claim it from the new tax year. My understanding of the lump sum issue is that as long as my other taxable income for the year that I claim the lump sum in falls below the tax threshold, £5435 for the 2008/2009 year the lump sum is not taxable. If I go above the threshold the lump sum is taxed at the level of my other taxable income. I do not need to claim the lump sum immeadiately, so I could wait until a year that my income is going to be less. I think I have 2 years to claim it.

That's about right Millie.
That's how I was reading it when I did the original post.
However if you have an income like part-time work, or company/private pension, bank interest etc. you need to add that to the pension you'll get that year (after you take the lump-sum) and that might push you over the threshold. In any case you appear to only pay tax on the lump-sum at the rate you pay on any income. That might be zero, 10%,22% or 40% depending on your circumstances.

Do you agree Mikeyorks? I've got the book today and that's how I see it on first interpretation but it will need to be read more than once!

Mikeyorks

Looking back at your OP .... it appears it's only the State Pension that pushes your wife into tax? If that is the case (10% rate goes - other than for savings - in April) then she would pay 20% on the lump sum.

But if you could organise it / juggle it (I read it the pension is paid from commensurate with the lump sum?) to get that paid towards the end of the tax year? ...... then you may be able to contrive a situation where her pay in the year + say a couple of weeks of pension ...... doesn't exceed her allowances. In which case the lump sum would be tax free .... despite she would start paying tax immediately after the next 6th April.

But if the deferral is in whole years? .... you're a bit stuck with the dates you've got?

oxters

Mikeyorks wrote: »

Looking back at your OP .... it appears it's only the State Pension that pushes your wife into tax? If that is the case (10% rate goes - other than for savings - in April) then she would pay 20% on the lump sum.

quote]
Yes, it's a bit complicated, I agree. However, my future daughter-in-law is currently training to be a tax accountant and I think I'll set her the problem as a little test!

My wife will have a modest £3k or so in income from a part-time income which would continue after s.p.age, + some income, circa £1.5k from investments + state pension so she would be paying tax at 10% and 22%. Therefore the entire lump-sum (no matter how much) would be payable at 22% - I think that's the deal even if the lump-sum would normally take you into a higher bracket, you only pay at the marginal rate.

She could do some manipulation of income to minimise the tax I think e.g. by only being liable to 10% in a given year thereby reducing the tax liability on the lump-sum to 10%.

She could always take the s.p. money and Spend,spend,spend - as long as she spends it on me!

Mikeyorks

oxters wrote: »

a modest £3k or so in income from a part-time income which would continue after s.p.age, + some income, circa £1.5k from investments + state pension so she would be paying tax at 10% and 22%.

No - she would be paying 20%. The 10% is only available, after 5th Apr 08, for savings income. As this is 'the top slice of your income' .... you can't have a situation where you get both 10% and 20%.

But that's a bit academic to the discussion. Even with £4.5k of income (pa next year £5435) .. you may be able to organise it that she takes the pension / lump sum (say)mid-March? So the 3 weeks or so of pension will not push her over £5435 .. as the lump sum isn't aggregated. Hence the lump sum becomes tax free!

oxters

Mikeyorks wrote: »

No - she would be paying 20%. The 10% is only available, after 5th Apr 08, for savings income. As this is 'the top slice of your income' .... you can't have a situation where you get both 10% and 20%.

But that's a bit academic to the discussion. Even with £4.5k of income (pa next year £5435) .. you may be able to organise it that she takes the pension / lump sum (say)mid-March? So the 3 weeks or so of pension will not push her over £5435 .. as the lump sum isn't aggregated. Hence the lump sum becomes tax free!

Ok, my brain hurts. Re "you can't have a situation where you get both 10% and 20%" - I thought you paid tax on the first bit of income at the 10% rate, then a higher rate (is it 20 or 22%?) on the next bit of income, and finally 40% on the remainder (if you earn that much). Did I get that much right or is the 20% a new flat rate for the first bit after April?

It looks like you are generally agreeing with my o.p. and # 5 above provided she carefully judges the timing of the lump-sum. Correct?

She will, of course be liable to tax in subsequent years as £3k + £1.5k+full s.p. for female bring her over the threshold. The only way I can see of avoiding the tax is to keep deferring the pension until she stops work, when assuming some increases in p.a. offset by increases in s.p. she might just marginally escape the tax man's clutches altogether?

Thanks very much for your views on this and sorry I am so woefully thick.

Mikeyorks

The tax bands are changing significantly from April. In essence the 10% band disappears but .. to confuse .. it is retained solely for savings interest. But that retention only applies (your interest goes on top of earnings / pension ... you can't decide you want it in the middle) where your savings interest falls somewhere between your pa (£5435) and the pseudo 10% band (somewhere around £2320 for 08-09).

In your wifes case .. from the figures given ... I think you can legally manipulate the lump sum to be tax free. If I've read (skimpily) it correctly ... once you've postponed the pension for at least 12 months .. you can call it in anytime. But it brings the weekly pension in with it. So if you call it in mid-March her earnings (£3k) + interest (£1.5k) + the couple of weeks pension £??) - will not exceed her allowances of at least £5435? So she is not taxable at that point ... therefore the lump sum is tax free!

Despite the fact that after the following 6th April she would (£3k + £1.5k + £full State Pension) be taxable. And she wouldn't have to cease work to do it that way. But you would have to have Pensions Service well organised to pay the pension + lump from a very specific date.

oxters

Mikeyorks wrote: »

The tax bands are changing significantly from April. In essence the 10% band disappears but .. to confuse .. it is retained solely for savings interest. But that retention only applies (your interest goes on top of earnings / pension ... you can't decide you want it in the middle) where your savings interest falls somewhere between your pa (£5435) and the pseudo 10% band (somewhere around £2320 for 08-09).

In your wifes case .. from the figures given ... I think you can legally manipulate the lump sum to be tax free. If I've read (skimpily) it correctly ... once you've postponed the pension for at least 12 months .. you can call it in anytime. But it brings the weekly pension in with it. So if you call it in mid-March her earnings (£3k) + interest (£1.5k) + the couple of weeks pension £??) - will not exceed her allowances of at least £5435? So she is not taxable at that point ... therefore the lump sum is tax free!

Despite the fact that after the following 6th April she would (£3k + £1.5k + £full State Pension) be taxable. And she wouldn't have to cease work to do it that way. But you would have to have Pensions Service well organised to pay the pension + lump from a very specific date.

Thanks again Mike. That's the way I'm seeing it too. Imagine the pension service sending out a book quoting outdated tax rates! The FSA would have something to say if banks quoted out-dated interest rates.

Another possibility is to do as you say, take the lump-sum on a convenient date, then start again applying for a deferred pension. AFAIK there's nothing to stop her doing that.