Monday 16 March 2015



The Chancellor is set to make £17 billion in extra tax over 16 years from Freedom and Choice in Pensions that began on 6 April 2015. From that date millions of people over 55 have the right to cash in their pension pot if they want to do so.

Usually cashing in a pension will not be a good idea. But where an individual does it they will face a big tax bill on the money taken from the pension fund. Three-quarters of the withdrawal will be added to their income and taxed. So the whole fund will normally have at least 15% taken off and paid to HMRC. If the total income in the year exceeds the level at which higher rate tax is paid - £42,385 in 2015/16 - then 40% tax will be paid on some of it. And if the total income is taken above £100,000 the tax rate will be more as the personal tax allowance is withdrawn - effectively a 60% tax on £21,200 of income - and then at £150,000 the top rate 45% tax will be due.

The deduction will normally range from 15% to 45% of the total withdrawn and settles down at 34% for the very highest combinations of income and pension withdrawals. Some with other income which is too low to pay tax could face deductions below 15%. Table 1 below shows the tax taken from the total pension withdrawals at various incomes. Table 2 shows the percentage of the total withdrawal that will be taken in tax.

Both tables use the total pension withdrawal including the tax-free part and give the tax taken on the taxable part. So £10,000 withdrawal has £1500 tax deducted which is 20% tax on three quarters of the total.

These tables give the tax due. In fact the amount taken off by the pension provider will be different. In many cases it will be more as HMRC insists that they assume the same withdrawal will be made every month for the rest of the tax year. That will result in much more tax being taken off in many cases. Any excess can be reclaimed using HMRC Form P53 or on the self-assessment form after the year end. In some circumstances the tax taken will be too little and further tax will be due.

This Fidelity calculator will work out the tax deduction if you enter your pension pot and income.

The tables assume that 25% of your pension fund can be taken tax-free. If you were a member of a scheme at work before 6 April 2006 it is possible that you can take a bigger percentage - conceivably up to 100%. That is called protected tax-free cash (sometimes called a pension commencement lumpsum). These arrangements are easily lost especially if you transfer your money from one scheme to another. Ask your scheme or adviser to tell you if this applies to you. If it does then the tax charge on the whole fund will of course be less. 

Warnings not given
Although pension providers will have to point out that some tax may be due on a pension withdrawal, they will generally not calculate the amount due or the amount that will be taken, though some have online calculators you may be able to use. The Government's Pension Wise service will not do the calculation either. So use the Fidelity calculator to work out your own approximate tax deduction.

Good independent financial advisers should be able to work out the tax you will have to pay - and the protected tax-free cash if you are entitled to it. The best independent financial advisers are chartered or certified financial planners. Find one through vouchedfor or unbiased. If you have a large fund the cost of consulting one may well be worthwhile. But if your fund is small they may not be interested in your business.

Remember that the money you take out will have to last fro the rest of your life. The Government has produced a life expectancy calculator to show what you can expect.  

Treasury savings
In the 2014 Budget when the pension 'freedom' was announced the Treasury estimated that the extra tax taken would be £320 million 2015/16 rising to £1220 million by 2018/19, a total of £3 billion in the first four years. The Treasury will continue to make money from the change until 2030/31 taking an extra £17 billion over those sixteen years. It will take another 56 years before that £17 billion is recouped from reduced tax receipts of around £300m a year on annual pensions that are not being paid. These estimates may well be too low as enthusiasm for withdrawal seems higher than anticipated. Updated figures published in the Budget on 18 March 2015 broadly confirmed the amounts estimated a year earlier.

Not annuity buy-back
These calculations are for pension withdrawals made from 6 April 2015. They do not apply to the proposal to sell annuities. Normally the tax due on a lump-sum payment for an annuity will be more than the figures show here as there will be no tax-free element in the amount. The details of how annuity buy-back might work are awaited and it will not happen until 6 April 2016 at the earliest.

16 June 2015
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