Understanding the amount of tax you will pay on your pension is a key part of the financial planning process.
The pension commencement lump sum (PCLS)
The PCLS applies to your personal pension (DC and/or DB), not your State pension.
The PCLS is a tax-free lump sum that can be taken when someone starts accessing their pension benefits. A person can take a maximum of 25% tax-free up to the lifetime allowance of £1,055,000. Meaning at the beginning of the pension drawdown process, 25% can be taken tax-free assuming it does not exceed £263,750.
After your tax-free amount, any other income taken from your pension is taxed at the normal rate of income tax.
Band Taxable income Tax rate
Personal Allowance Up to £12,500 0%
Basic rate £12,501 to £50,000 20%
Higher rate £50,001 to £150,000 40%
Additional rate over £150,000 45%
Tax in retirement works in the same
In retirement, you are subject to income tax on any income streams you may have, in the exact same way everyone else is taxed. Common income streams for pensioners include your state pension, earnings from employment or self-employment, rental income and income from investments that are liable for CGT.
Regarding the 25% tax-free amount, this can be taken in a range of ways.
The 25% tax-free amount
There are 2 ways you can take your tax-free amount.
Take it all in one go
You can take 25% as a lump sum without paying tax. If you do this, you can’t leave the remaining 75% untouched. You can either:
buy a guaranteed income (annuity)
get an adjustable income (Flexi-access drawdown)
take the whole pot as cash
Your pot is £60,000 and you take £15,000 – this is your tax-free lump sum. You buy an annuity with the remaining £45,000 which pays you £2,000 a year. This money is taxable.
You can take it in chunks
The PCLS can be taken as cash lump sums from your pension pot without paying tax. Each time a withdrawal is made 25% (assuming it is cumulatively under £263,750) is tax-free with the of each chunk is tax-free with the remaining 75% been liable for tax dep
If you continue to work
Your employer will take any tax you owe off your earnings and your State Pension. This is called Pay as You Earn (PAYE).
If your total income (including money from pensions and PAYE) is £100,000 or more for the tax year, or if you’re self-employed, you’ll have to fill in a Self-Assessment tax return.
If you have other forms of income it is important you must complete your self- assessment tax return.
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