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April 2018 – Pension flexibility … continued … How much tax will I pay?

Last month we explained the details of flexibly accessing a pension pot. We will now explain how it works when you take up this option and, most importantly, how much tax will be deducted at source.

Taking all of your Pension Pot - If you choose to take all your money from your pension pot an “emergency” tax code will be used to deduct the tax. The first 25% of the value of your pot will be tax free and the balance left will be the taxable amount. The emergency code will tax the first £988 @ 0%, the next £2,875 @ 20% and the next £9,625 @ 40%. If your taxable lump sum exceeds £13,487 any further tax will be deducted @ 45%.

Let’s look at some examples for the 2018/19 tax year:

  • Pension pot value £10,000.  25% tax free amount = £2,500. Taxable amount = £7,500. Tax deducted at source on emergency code as explained above will be £2,030.
  • Pension pot value £30,000. 25% tax free amount = £7,500 taxable £22,500. Tax deducted will be £8,480.
  • Pension pot value £60,000. 25% tax free amount = £15,000 taxable £45,000. Tax deducted will be £18,605.

At this point you will probably be thinking that surely the tax man shouldn’t take so much tax out of my hard earned pension and will need to sit down for a cup of tea, if not something stronger! But please keep in mind, the vast majority of people who access their pension pots in this way will have paid too much tax.

Tax is overpaid because the emergency code works on 1/12th of your annual allowances and assumes you will get this inflated income each month. However, when you calculate it annually, income between £11,851 and £34,500 is taxable at 20%, the next £115,500 at 40% and over this at 45%.

The actual tax due depends on the amount you take out of your pot and what your other taxable income is in the tax year concerned.

Claiming the Tax Back - The good news is this: you can claim it back immediately by completing form P53Z. It can be downloaded from HMRC’s website. There are options to complete the form online or to print off a paper copy and post. You can also call HMRC to request a paper form. Your pension provider will have sent you a P45; HMRC will need this but take a copy first.

Please note: If you are in receipt of the marriage allowance and taking the lump sum puts you into the higher rate tax band then this allowance no longer applies. It is only given if both parties are basic rate tax payers.

Taking Part of your Pension Pot – Some people choose to take regular or ad hoc withdrawals rather than taking everything in one go. With this option there is also a choice as to how the 25% tax free element is taken. It is possible to withdraw all of the 25% element in one go or to take 25% of each withdrawal tax free. The first time the pot is accessed emergency code is used as explained above. If a tax refund is due and there is no intention to access the pot again during the tax year, form P55 can be completed and sent to HMRC. If the pot is to be accessed again during the same tax year, the provider will inform HMRC and a tax code will be issued for future withdrawals; you may get any refund via these payments or at the end of the tax year. It might be worth contacting Tax Help to check that it is all working correctly.

Posted in: Tax Tips