7th September 2015 at 3:53pm
The new pension freedoms have thrown the doors wide open on how we choose to access our savings in retirement.
Pensions are still one of the most tax-efficient ways to save but you need to make sure you don’t sacrifice these benefits when taking your money out.
How to have a tax-efficient retirement is one of the most popular topics on our MoneyPlus community and MoneyPlus blog. We thought it might be helpful to pull together a short Q&A to cover some of the points being discussed.
Here’s our top tips:
How much of your pension can you take tax free (tax efficient)?
You can dip into your pension whenever you like from age 55 and normally get the first 25% tax-free. You can take this as one lump sum or in stages.
What tax am I likely to have to pay?
It will depend on your income but everyone has a personal tax allowance (normally £10,600 for the tax year 2015-2016) which you don’t pay tax on. The rest of your income is taxable.
If you take money out gradually over a number of tax years you could keep more of your savings. Take a large, one-off sum, or your entire pension as cash, and the tax will probably be much higher, particularly if you’re still working and have used up your personal tax allowance.
How can I take my pension tax effectively over a number of years?
You need to consider what other income you have and be aware of the different tax bands and rates that apply. This means you can work out how much of your pension you can take without moving up into the next tax band. GOV.UK will give you the rates and bands you’ll need to check this.
Here’s an example: You’ve a £50,000 pension with 25% of this tax free, leaving £37,500 liable to tax. If you have no other income, your personal tax allowance, £10,600 for most people, is available leaving £26,900 which is subject to tax at 20%.
However, if you had other income of £20,000, your personal tax allowance will be used against that income and you’ll have to pay 40% tax on some of your pension money.
What’s the difference if I continue working and access my pension?
If you’re still working, your personal allowance isn’t available as it is being used against your employment earnings so it’s possible you’ll pay higher rates of tax on some or all of your pension money.
When calculating tax will all my income be taken into account?
It depends on the source. Money taken out of a bank account or an ISA isn’t subject to tax. But money from other sources such as the state pension, other private pensions and dividend income will be. To be tax efficient you need to be aware of all your sources of income.
Emergency tax – how does it work and how can I reclaim it?
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.
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 upfront. 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 good news is that you can reclaim this overpaid tax by simply filling in a form for HMRC. The forms can be found here , and it’s currently only taking HMRC a few weeks to make the payment.
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%.
For more help
These are just a few things to think about but it’s a good idea to seek appropriate guidance or advice to understand all your options. You can access the Government’s free Pension Wise service provided through Citizen’s Advice or The Pensions Advisory Service. This guidance can be accessed online, by telephone or face to face.
We’ve also got a useful guide, ‘Information about tax relief, limits and your pension’.
This information is based on our understanding of taxation legislation and regulations in September 2015. The legislation and regulations can change. Your personal circumstances also have an impact on tax treatment.