I have a small works pension valued at approximately £9,000. I am 61 years old and due to retire at the end of March.
Today I called my pension firm which advised me if I make my pension up to £10,000 then I would be able to take £2,500 for the next four years, and all of this would be tax-free as it falls into different tax years.
I then spoke to Pension Wise who advised me that this information is not correct and that only the first 25 per cent is tax free. Would you be able to advise please.
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Retirement money: How will a work pension pot worth £9k be taxed when I retire, because I’m being given confusing advice on this?
Steve Webb replied: I can understand why you were confused by the apparently conflicting information which you were given. I hope that I can clarify what is going on.
As you were told by Pension Wise, once you are over 55, the basic idea is that a quarter of your pension pot can be taken tax free, and the remainder counts towards your taxable income in the year in which you take it.
This means that if you wanted to take a £10,000 pension pot in one go you would receive £2,500 tax free, and the remaining £7,500 would count as taxable income in that year.
However, the actual amount of tax you would pay would depend on what other income you had in the same year.
For example, you mention that you are currently working. If you took the pension pot out in full this year, the £7,500 would be added to your wage and you could easily end up paying tax on the whole amount.
However, your provider is suggesting that you do something different.
Instead of taking the money all in one go, you would wait until you have retired and then take out ‘chunks’, with each chunk being 25 per cent tax free and 75 per cent potentially taxable.
As you had retired (so didn’t have a taxable wage coming in) and hadn’t reached state pension age (so didn’t have a taxable state pension coming in) then the 75 per cent would be well within your tax-free personal allowance.
So although this part of your withdrawal is included in your taxable income, you wouldn’t actually pay any tax because it would be covered in full by your personal allowance.
There are, however, a few other things to think about.
The first is to think what you are actually going to live on, if you have stopped work and haven’t started drawing a state pension.
It seems unlikely you could live on a £10,000 pension pot spread over four years.
If you will have other income coming in (such as an occupational pension or income from a rental property) then this could gobble up your personal allowance for the year and mean that your chunks of private pension would take you above the tax-free allowance and be taxed after all.
Did you miss out on a state pension lump sum if you were widowed?
This is Money’s columnist Steve Webb calls on elderly widows who might have missed out on a backpayment when their husbands died to get in contact.
He wants to help people get money that is rightfully theirs, and find out if there is a systematic problem not picked up in the Government’s massive correction exercise for elderly women who were underpaid.
Find out if you could be affected, and how to contact Steve here.
> Did you miss out on state pension if you were widowed in retirement?
The second interesting thing is that your provider suggested you top your pension up to £10,000.
Leaving aside whether they sailed a bit close to giving you financial advice, it initially surprised me that they linked the ability to take pension in chunks to the amount you had in the pot.
However, I’ve checked your provider’s website and they do say that the minimum pot size you must have before you can take your pension in ‘flexible chunks’ is £10,000, and this would be why they have suggested you top up before you could go down this route.
One final practical thing to be aware of is that the first time you make a withdrawal, HMRC may ask your provider to deduct tax using an ’emergency’ tax code.
HMRC do this because they think you may make lots of withdrawals which would clearly take you above the tax threshold. But if you only plan to make one withdrawal a year you can fill in a form and get the tax back off HMRC.
You should also be aware that once you start taking taxable cash from a pot worth £10,000 or more, you trigger a tighter limit on the tax relief you can get on any future pension savings.
If you don’t plan to do any more pension saving in the future then this need not trouble you, but if there’s a chance you might go back to work and pay into a pension again you should be aware of this.
I’ve written more about this ‘Money Purchase Annual Allowance’ here.
