Caught by the pension tax trap?

Those looking to cash in part, or all, of their personal pension need to check they don’t pay too much tax.

Pension freedom rules allow anyone aged 55 or over to access their personal pension funds, but there are complex rules on how withdrawals are taxed. Problems can occur if you take a one-off lump sum – an ‘uncrystallised fund pension lump sum withdrawal’ (UFPLS) – perhaps to re-invest or to pay off debts. This differs from using a personal pension to provide a regular income, through a drawdown plan or annuity.

Your pension provider will apply an emergency tax code, which assumes you are withdrawing the UFPLS on a monthly basis, unless it has an up-to-date tax code for you.

For example, if you take a UFPLS of £10,000 at the start of the tax year, HMRC may assume you will take an income of £120,000 across a year from your pension and tax you accordingly. If it is a one-off withdrawal, you are likely to pay too much tax.

Avoiding the charge

As emergency tax codes are generally only applied the first time people access their pension funds, one option is to make your first withdrawal a nominal amount, say £100.

The emergency tax code is still applied, but this triggers HMRC to adjust your tax code and send an updated version to your pension provider. Once the new code has been issued, any further, larger withdrawals are taxed correctly.

You may be able to claim a rebate, either through your tax return at the end of the tax year, or by submitting the appropriate form to HMRC if you need the rebate more quickly.

If you are planning to withdraw a lump sum from your pension, or are concerned about a recent withdrawal, please get in touch.

The Financial Conduct Authority does not regulate tax advice.

Levels and bases of taxation and tax reliefs are subject to change and their value depends on individual circumstances.

Tax laws can change.

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