15th April 2015 at 8:22am
Don’t trip up on tax, when it comes to taking money out of your pension.
Tax can be one of the reasons to consider taking money of out your pension gradually, spread over many tax years, since it can mean you keep more of what you’ve saved.
You may pay too much income tax when you take out a large one-off lump sum or fully encash your pension.
The emergency tax code
This can happen because, if you’ve not taken money out of your pension savings before, your pension provider won’t have an up-to-date PAYE tax code for you. This means it has to follow HM Revenue and Customs rules and apply what’s called the ‘emergency tax code’.
The emergency tax code works by assuming a ‘month 1’ basis.
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 is applied to the money you receive. The emergency tax code assumes that the payment you are receiving will be the first in a monthly sequence of payments over the year ahead.
When you’re only taking 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.
Smaller pensions not affected
The emergency tax code doesn’t apply when you’re taking money out of a pension which has a total value of £10,000 in total – in other words, when your withdrawal is under the ‘small pots’ rule. You’ll get 25% tax free with the rest taxed at 20%.
And tax free lump sums will continue to be paid free of tax.
How to get a tax repayment
There are different types of form, depending on your personal circumstances.
The website for HM Revenue and Customs states it will usually send repayments within 5 weeks, but it may take longer in some cases.
And if you usually file a tax return, that’s also a way of claiming a tax refund, although you’d have to wait until after the tax year ends on 5th April 2016 before filing a tax return for the current year. It will be interesting to see if the move to digital tax accounts allows this process to be speedier.
This blog and any responses to comments are 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.