20th May 2015 at 12:14pm
Don’t trip up on tax when it comes to taking money out of your pension.
Tax is one of the main things you need to consider when taking money out of your pension, particularly in light of the recent pension freedoms which allow people to access their pension funds from the age of 55 and take as much of their money when and how they want to.
Take it out gradually over many tax years and it can mean you keep more of what you’ve saved; take out a large, one-off lump sum or your entire pension as cash and you may pay too much income tax – much more than you’d thought. This could be as much as double the amount you actually need to pay.
This is because if you haven’t taken money out of your pension savings before, your pension provider won’t have your up-to-date PAYE tax code. This means they have to follow HM Revenue and Customs’ rules and apply the emergency tax code.
Understanding the emergency tax code
The standard tax-free personal allowance for tax year 2015-16 is £10,600, but when the emergency tax code applies only one-twelfth of this allowance is applied to the money you receive. The assumption is that the payment you are getting is the first of a monthly series over the year.
When you make a one-off withdrawal this can mean too much tax is taken off. You are, in effect, pushed into a higher tax band, so 40% or even 45% income tax might apply to part of the money you take out, before it is sent to you.
The emergency tax code doesn’t apply when you’re taking money out of a pension pot valued at up to £10,000, when your withdrawal is under the ‘small pots’ rule. You’ll get 25% tax free with the rest taxed at 20%.
How to claim tax back
The good news is you can do something about it by claiming a tax refund. Fill out a form on the HM Revenue and Customs website or claim the refund via your tax return if this applies to you.
You can find out more about tax and the emergency tax code on the HMRC website www.gov.uk
This article is not financial advice. Standard Life is not responsible for the content on any external websites. Tax and legislation can change in the future and this represents our understanding of the rules in April 2015.