Pension Freedom – How To Pay Less Tax

Pension providers must deduct income tax from any payments they make to you in the same way an employer takes tax and national insurance from your salary.

This can trigger tax issues for some retirement savers if the tax due on any pension withdrawal is set off as an emergency tax because the personal allowance is allocated to an employer.

As emergency tax, the pension payment is treated as 1/12 of your annual income, with tax calculated accordingly.

The overpaid tax will be refunded once claimed from HMRC, but this may take several weeks.

If you have more than one pension or income from other sources you must keep track of your income and pass the details to each provider.

Saving tax on pension withdrawals

Some strategies that may stop one-off uncrystallised withdrawals pushing you into the higher rate tax band for the year include:

  • Only withdrawing the 25% tax free lump sum and leaving the rest of your pension untouched until you retire and your income drops into the basic rate tax band
  • Schedule withdrawals to stay within your annual income in the basic rate tax band each year
  • Take uncrystallised drawdowns but reduce other income. Some ways you could do this would be deferring the State Pension or carrying on working but trading as a company and drawing dividends to stay in the basic rate tax bracket
  • Consider taking large pension pots as smaller, yearly amounts. You can take one at the end of the tax year and one at the start of the next to double your withdrawal and still pay basic rate tax.

Planning your income

The risk with flexible access is you could run out of retirement cash if you do not keep a close eye on your spending.

The problems are:

  • You do not know how long you are likely to live, so have no certainty of how much you should draw each year
  • You withdraw to much cash too soon, leaving too little for your later years or to fund long-term care
  • Retirement investments may not perform as expected and fall short of the predicted amount of cash you need, so you need to review them regularly to stay on track
  • If your pension fund or funds add up to more than £10,000, if you start taking income, the amount you can put back into a pension drops from £40,000 a year to £10,000 a year

What happens when you die?

This depends on your age – in either case you can nominate one or more people to inherit any unused cash in your pension:

  • If you die under 75 – the money passes to your beneficiaries and as long as they start taking the cash within two years of your death, they are tax-free. After that, they pay income tax.
  • If you die over 75 – your beneficiaries pay income tax on any money they take at their marginal rate, except if they take the entire fund as a lump sum before April 2016, when the cash is taxed at 45%.

Free pension advice

If you want to discuss your pension options, the government has set up a free advisory service called Pension Wise

Free advice is also available on from the Money Advice Service

You can also talk to an independent financial advisor, but most will charge a fee for their time.

Many pension providers also offer financial advice, but they are only allowed to talk about their own products and services, so you may find a better deal elsewhere but they will not tell you the details.

Retirement savers with smaller pension pots – generally up to a total of £30,000 across several schemes – do not need to take financial advice before taking their money.

However, those with funds of more than £30,000 must take financial advice.