I’m taking a 25% tax-free lump sum from my pension, but how will the rest be taxed? Steve Webb replies
Pension withdrawals: After I take 25% tax free, what happens to the rest?
I am in the fortunate position of being able to claim 25 per cent tax free from my Standard Life pension and also from another in a Hargreaves Lansdown Sipp.
Is there a point or time where the rest is tax free, or is the remaining 75 per cent taxable and how is the tax taken off?
I would appreciate any advice you can give me.
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Steve Webb replies: There are various ways in which you can access your pension pot and the amount of tax you pay and when you pay it is different in each case.
Let me run through the main options.
1. Withdraw the pot in full
Once you are over the normal minimum pension age (currently 55 in most cases, though rising to 57 in a few years’ time), you can access your pension in full if you wish.
If you take the whole lot out, you can take 25 per cent tax free and the remaining 75 per cent is taxed as income in the year in which you draw it.
You would be paid the balance net of tax.
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In practice they may initially take too much tax and you may have to claim some of it back. But once that was sorted out you would end up simply paying normal income tax on the 75 per cent.
2. Take up to 25 per cent tax free and buy an annuity with the rest
If you chose to use the balance of your pension after the tax free cash to buy a regular income – an annuity – then income from the annuity is taxable.
Your annuity income would be added to income from other taxable sources (earnings, state pensions, occupational pensions and so on) and you would be taxed in the normal way on the total amount.
3. Take up to 25 per cent tax free and leave the rest in ‘flexi-access’ drawdown
In this case you take all your tax free cash up front and the balance is invested in a drawdown account which you can access flexibly.
The money continues to grow tax-free while it is inside the drawdown account, but each chunk you take out is taxable in full, and is simply added to your taxable income for the year.
4. Take your pension in a series of lump sums, with each withdrawal partly taxed and partly tax free
This option is known in unlovely pension jargon as ‘uncrystallised funds pension lump sum’, and you might sometimes see it abbreviated to UFPLS.
In this version your whole investment is held in a drawdown account and each withdrawal is 25 per cent tax free and 75 per cent taxed when you take it out.
Assuming that the untouched pot continues to grow, you will end up getting more tax-free cash overall, but the benefit of tax free cash will be spread over the lifetime of the account rather than being received right at the start.
A summary of the different ways of accessing a ‘pot of money’ pension can be found on the MoneyHelper website here.
One important point to be aware of is that each decision on what to do with each of your pots is entirely separate.
In particular, if you wish to do so, you can access them at different times and in different ways depending on your situation at the time.
In the event that the running total of your withdrawals takes you over the Lifetime Allowance (currently £1,073,100) a further tax charge would apply, and you can read more about the rules for that here.
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