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The tax implications of pension
fund withdrawal
Since April 2015, individuals with a defined contribution pension fund have
been able to withdraw their pension monies as a lump sum, and choose how
to invest and spend it throughout their retirement.
What may be overlooked by many retirees, however, is the resulting tax position that comes from withdrawing a lump sum
from their pension. The examples below use scenarios for individuals at different stages in their retirement, and review the
resulting tax situation.
Please note the following case studies are intended to be a high level overview. Should you decide to withdraw funds from
your pension the amount of tax you pay initially will vary depending on your personal circumstances.
Case Study 1:
The assumptions for this example are for
an individual aged 65, who has a pension
pot of £30,000, doesn’t receive any
benefits, and whose only other income is
the state pension, and wishes to withdraw
their entire pension pot as cash.
The net effect of this is that the individual’s
£22,500 remaining pension fund would
now only be worth £18,915 (£22,500 –
£3,585), so they would receive 63% of the
fund rather than 75% (after tax free cash
is taken).
If this individual had made full use of their
personal allowance, and withdrawn the
pension fund gradually over a number of
years, they could have received all of their
remaining pension fund.
Case study 1
Total pension pot:
Tax free cash (25%):
Remaining pension pot:
State pension (2015/16 tax year):
£30,000
£7,500
£22,500
£115.95pw
(£6029.40 pa)
Once the 25% tax free cash lump sum is taken, the remaining 75%
is treated as earned income, and taxed through PAYE; the tax
calculation is:
Taxable income: £6,029 + £22,500 =
£28,529
Personal allowance (0% tax band) =
£10,600
Taxable income after allowance =
£17,929
Income taxed at basic rate: £17,929 x 20%
=
£3,585
Cont.
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The tax implications of pension fund withdrawal
For the purposes of this case study, we’ll assume the personal allowance and pension fund remains unchanged:
State pension
=
£6,029
Personal allowance
=
10,600
Remaining unused personal allowance
=
£4,571
Withdrawal of remaining pension fund: £22,500
=
4 payments at £4,571 (£18,284) +
1 payment at £4,216
By spreading the pension fund withdrawals over a period of five
years, this individual would receive the full value of their pension
fund, and remain a non tax payer.
Of course, the financial circumstances of the individual will dictate which route is taken: that is, if the priority is the
repayment of debts then a one off lump sum may be preferable.
However, if the pension funds are being withdrawn to provide additional income, then full use of allowances should be
considered. It’s important to note though that this option will not offer the client the security of not running out of money
that a guaranteed income for life solution (provided by a pension annuity) does.
Case Study 2 :
For this example, we’ll consider an
individual aged 60, with a £150,000
pension pot, a salary of £25,000 pa,
and no other benefits. They are not
yet ready to retire, but would like to
use £50,000 of their pension pot to
supplement their income.
There are various ways to access these
pension funds, and each one will have a
different effect on the client’s overall tax
position. Therefore seeking financial advice
can help establish which approach is the
most appropriate for them.
In this instance, by
withdrawing a lump sum
of £50,000 to supplement
income, the individual
has been pushed into the
higher rate tax band.
Case study 2
Pension pot being utilised: Tax free cash (25%): Remaining pension pot: Salary: £50,000
£12,500
£37,500
£25,000
Once the 25% tax free cash lump sum is taken, the remaining 75%
is treated as earned income, and taxed through PAYE; the tax
calculation is:
Taxable income: £25,000 + £37,500 =
£62,500
Personal allowance (0% tax band) =
£10,600
Income taxed at basic rate: £31,785 x 20%
Income taxed at higher rate: £20,115 x 40%
=
=
£6,357
£8,046
Total tax to pay =
£14,403
Taxable income after allowance = £51,900
By contrast, the salary of £25,000 on its own would have produced a tax bill of £2,880, so the net effect of withdrawing
£50,000 from the pension is an additional £11,523 payable in tax. This means that rather than receiving the £37,500
remaining fund, the net position would be £25,977 (£37,500 - £11,523), or around 52% rather than 75% of the pension
fund (after tax free cash is taken).
Cont.
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The tax implications of pension fund withdrawal
For investment purposes, this means the individual now has £38,477 (£12,500 + £25,977) to provide additional income.
Although this route offers the individual total flexibility, there are alternative methods of producing income that could prove
more tax efficient:
• An annuity that offered a rate of 5% for example would produce an income that is not only guaranteed for life, but
would add around £1,875 to this individual’s gross earnings, keeping them well within the basic rate tax band, whilst
achieving the goal of supplementing income.
• The use of a drawdown facility could also be used, although this comes with ongoing investment risk and would not
offer any guarantees of not running out of money. However, the individual could take up to £17,385 pa from their
pension savings and remain within the basic rate tax band.
Summary
The pension freedoms that are now in place will provide flexibility for anyone considering accessing
their pension savings. Depending on personal circumstances, this can of course make sense for
some, for example, if outstanding debts such as a mortgage need to be cleared before proceeding
into retirement.
However, individuals must be fully aware of the tax predicament they could find themselves in to
benefit from this flexibility, and will need to ascertain if they wish to pay tax so readily when (with
careful planning) they could provide a different outcome.
Lastly, it’s important to help clients keep in mind what they actually need from their pension fund. If, for
example it’s a guaranteed income for life then a pension annuity is the only product that can offer this
without exposure to investment performance risk . And, if pension funds are withdrawn, they will need
to provide a replacement income during their retirement.
Find out more on justadviser.com
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Sales support telephone: 0345 302 2287
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Email: support@justretirement.com
Or log onto our website for further information:
www.justadviser.com
Call 0345 302 2287 or visit www.justadviser.com
For more information contact:
Telephone: 01737 233297
Lines are open Monday to Friday, 8.30am to 5.30pm.
Alternatively you can email us:
support@justretirement.com
Or log onto our website for further information:
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1031563.2
06/2015