fbpx

Making a Withdrawal: Pension Payments

Making a Withdrawal Pension Payments

Attractive tax reliefs are available on contributions to a personal pension plan and to the plan itself, but the focus here is on the basic income tax implications when the saver wishes to draw money from that pension. The past 20 years or so have seen the introduction of more flexibility, and since 2015 flexi-access drawdown has meant that savers can generally draw from their pensions without restriction if they are aged 55 or over.

 

The Lump Sum

Up to 25% of the value of the accumulated value of a personal pension plan can be withdrawn as a taxfree lump sum. This does not have to be taken as a single payment and it could be taken over a period of years. A lump sum could be a useful resource if cash is required to meet unexpected expenses without incurring a tax liability.

 

Annuities

Taking an annuity from a pension still exists. The saver gives up the right to the capital in return for an annual amount (often paid monthly) for the rest of their life or perhaps the life of their spouse or partner. Various options are available, including (for example) the annuity being guaranteed for a set period, for a fixed or increasing amount. The annuity is subject to income tax at the appropriate rate.

 

Drawdown

As mentioned, funds can be drawn from a personal pension plan as required. Once the tax-free element has been taken, any other withdrawals are taxed as income. Income tax will be charged at the appropriate rate (i.e., 20%, 40% or 45% – the same rates that would apply to annuity income) on total income above the annual personal allowance (£12,570 for 2023/24). Note that different rates apply for Scotland.

Other sources of income – state or work pensions, other earnings, and savings income, etc – should be taken into account when calculating the liability likely to arise on the drawn down money. For example, if Mr Smith had a pension plan worth £100,000, he could take £25,000 as a tax-free lump sum. If the whole pension fund was withdrawn, the other £75,000 would be taxed as income in that year. Let’s assume that he has a state pension and some part-time earnings that are the same as his personal allowances of £12,570.

For 2024/25, the first £37,700 of the pension would be taxed at 20% and the balance of £37,300 would be liable at 40%. The total tax due would be £22,460. However, if he drew it in two payments over two tax years, £37,500 would be taxed in the first year at 20% and the same in the following year. Assuming his circumstances remain the same, the two taxable amounts of £37,500 would both be taxed at 20% – a total income tax liability of £15,000, so a tax saving of £7,460. Of course, the payments do not need to be a year apart, simply in two tax years.

As an aside, the operation of the PAYE system (often involving the use of the ‘emergency’ tax code) means that higher amounts of tax may initially be deducted from individual drawn down funds. Repayments may be claimed through the HMRC website (www.gov.uk/claim-tax-refund).

 

Conclusion

There are numerous other tax implications to pension withdrawals, and advice should be taken. For example, withdrawals from a pension other than the tax-free element will reduce the maximum amount that can be paid into a pension in future. This may be important if future employment or self-employment is being considered. Entitlement to personal allowances may also be affected.

 

Practical Tip

The tax liability on pension withdrawals is only one element. Consideration should be given to annual financial requirements, likely life expectancy and other factors. Professional financial advice is highly recommended.