Navigating the complexities of pension tax can feel like a daunting task with so many different options and implications. As financial advisors, we can help you plan for your pension, taking into account how much tax you’ll be required to pay at each stage.
In this article we look at the different ways to take your pension along with strategies to minimise the tax impact.
Understanding Pension Taxation
What is Taxable Income?
Taxable income includes various sources such as the State Pension, Additional State Pension, private pensions, earnings from employment, and any other income like investments or property. Individuals pay tax if their total annual income exceeds the Personal Allowance, which is the amount of income you can earn before having to pay Income Tax.
Tax-Free Lump Sums
Most pension schemes allow a tax-free lump sum withdrawal. Typically, you can take up to 25% of your pension pot tax-free. This provision is designed to provide financial flexibility without impacting your Personal Allowance.
Income Tax Rates for Pension Income
Income from pensions is taxed similarly to other types of income. The basic tax rate is 20% for income between £12,571 to £50,270, with higher rates applying to larger incomes. Taking large sums from your pension may push you into a higher tax bracket, potentially increasing your tax liability at the end of the tax year.
Different Ways to Take Your Pension
When planning how to access your pension, there are several options available, each with its own financial implications. One common method is the lump sum withdrawal, where individuals can typically withdraw up to 25% of their pension pot tax-free. This approach provides a significant upfront sum that can be used for large expenses or investments.
Alternatively, regular withdrawals can be structured to provide a steady income stream, similar to a salary. This method allows for better budget management and can help in maintaining a consistent lifestyle post-retirement.
Lastly, a combination of methods can be used, where part of the pension is taken as a lump sum and the remainder is used for regular withdrawals. This strategy offers both immediate financial relief and long-term income security, making it a preferable option for many retirees.
When choosing how to take your pension we recommend thinking about your personal and financial goals, plus the tax implications and their impacts.
Strategies to Minimise Tax on Your Pension
Drawdown Schemes
Pension Drawdown allows individuals to manage the size and timing of their withdrawals to minimise tax liability. By only withdrawing enough to stay within the personal allowance or the lower tax band, pensioners can significantly reduce the amount of tax paid on their income.
Utilising Personal Allowances
Taking advantage of personal allowances is crucial. Individuals should consider withdrawing just enough to remain in the lowest tax band, thereby preserving more of their pension savings. This strategy ensures that they do not pay more tax than necessary and optimises the use of their tax-free entitlement.
Small Pension Pot Exemptions
For smaller pension pots, certain rules allow for tax-efficient or even tax-free withdrawals. Pensions valued at £10,000 or less can be cashed in without triggering the money purchase annual allowance, offering a beneficial option for those with smaller savings. This exemption can be used up to three times for personal pensions.
Seeking Professional Advice and Planning
Engaging a financial adviser can help you manage your pension and tax liabilities efficiently. At The Bateman Group, our pensions advisors offer tailored guidance to help you mange your pension in the most effective way, potentially saving substantial amounts in the long term.
Get in touch to get your personalised pensions advice.
