Pensions Freedom - Don't give
your life savings to the Taxman
By Ian Mulcahy
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You've worked hard for your pension pot and from 6 April 2015 you are
free to do with it as you please. Before you rush out and a put deposit on a yacht or an Aston Martin, please consider how much of that hard earned Pension pot you want to give to the Taxman - most people will answer 'as little as possible'! 75% of any money you withdraw from your pension is taxable as income and that means you could be paying a tax rate as high as 60% on some of your withdrawal. This page explains how your pension withdrawals will be taxed, gives some ideas on how to avoid paying more tax than you need to and provides a calculator to work out exactly how much tax you will be paying. |
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During the course of your working life you and/or
your employer made contributions into your pension plan, and these
contributions enjoyed tax relief. This wasn’t a free gift from the
Government! Before April 2015, the normal procedure on retiring was that you took (up to) 25% of your fund as a tax free lump sum and used the rest to purchase an annuity. The income from that annuity would then be treated as taxable income and given to the taxman before you see it, a bit like wages. When you draw a large lump sum under the new
pensions freedom rules, the temptation might be to see the withdrawal as
though you were taking it out of a savings account, but you need to give
consideration to your tax position because withdrawals are also treated
as taxable income. A large withdrawal may take you into a tax band that
you do not normally fall into. For the tax year 2020/21 the tax bands
and rates are as follows: Say for arguments sake that your 'other income' amounts to exactly £12,570, so using all of your personal allowance. You can withdraw £50,266 and still pay only the basic rate of tax on £37,700 (after allowing for 25% to be taken tax free). The tax bill on your withdrawal will be £7,540 leaving you with £42,726. A large amount of tax, I'm sure you'll agree, but there's not much you could do to minimise your tax in this scenario. Lets have a look at another scenario. You are not yet eligible for the State Pension, you have been made redundant and you are not eligible for Job Seekers allowance anymore as your spouse is still working. You have no income at all. You decide to cash in your entire pension pot of £240,000 to pay off the mortgage and other debts, leaving a bit for treats. Your tax bill will be £65,960! Maybe you would be better served withdrawing the same amount spread equally over 5 years (£48,000 a year) which would give you a tax bill of £23,430 instead; a saving of over £40,000! (based on 2021/22 tax rates and bands and assuming that you have no other income for the entire period). TAX CALCULATOR (England, Wales & Northern Ireland only) To calculate the tax liability that will be generated by your withdrawal, enter your expected income for the tax year in the first box (remember to include all items mentioned above) and your proposed withdrawal in the second box. Taxable Income in tax year of withdrawal Amount to be withdrawn |