Tax in retirement Tax on pensions
Since April 2015, anyone aged 55 or over has been able to cash in their entire pension pot. But if you were to, say, blow an entire pension on a Lamborghini (£288,795), the tax you'd pay would be enough to buy the Treasury a Porsche (£126,206). And you'd need a pension pot of around £415,000 to start with.
Which? has created a calculator to show you how much tax you'd pay if you took your whole pot, or a chunk of it, as a lump sum. Further down, we explain the tax on other income sources in retirement.
How much tax will you pay on a pension lump sum withdrawal?
Since April 2015, you have been able to cash in all, or some, of your pension pot if you are 55 or older, even if you're not ready to start a pension yet. The first 25% of the withdrawal is tax-free; the rest is taxed as extra income.Calculate your tax
Developed in association with Jonquil Lowe, JTL Financial Research
How much do you want to take?
What's the lump sum you want to withdraw? This can be all or part of your pot.
If you expect to have other income during this tax year - for example from private pensions, rental income or the state pension - include that here. Don't include income from savings and investments.
What you get, and what tax you pay
If you cash in xxx, you will pay xxx in tax.
This means you'll receive xxx after tax, which includes a tax-free lump sum of xxx.
Whether you take your whole pot or just part of it, 25% of the withdrawal is tax free. The rest is taxed as income. Making a series of smaller withdrawals over several years can mean less tax than if you take your whole pot at once.
Find out more about options for pension income, under the 2016 rules.
Tax on a pension lump sum
From age 55, if you have a defined contribution (DC) pension (where you've built up pension savings over your working life), you can take a 25% lump sum tax free; you can take more, but you'll pay income tax on anything above 25%. If you leave your pot invested and take out smaller amounts, ad hoc, you'll get 25% of each withdrawal tax free. Use our calculator to see the tax you'd pay.
Emergency tax on pension withdrawals
Tax on pension pot withdrawals will be deducted at source, via the 'Pay-as-you-earn' (PAYE) system rather than through a self-assessment tax return. In many cases, the scheme provider will need to use an emergency tax code to do this. This code assumes you receive the same amount each month – and treats the sum you receive as one twelfth of your annual income. More tax than is due could therefore be deducted. HMRC will eventually refund the extra, but the process could take months unless you actively claim a refund using the relevant HMRC form - P55, P50Z or P53Z – in which case it should take no more than four weeks.
If your pension provider already knows your tax code for the year, and the correct amount of personal allowance you should receive, it can use this instead of an emergency code. This means that there is less risk of overpaying tax and having to claim this back.
Tax on state pensions
Contrary to what many people think, the state pension is not tax-free, but the money you receive is paid 'gross' - without any tax being deducted.
If your total income from all sources, including the state pension, is greater than your tax-free allowance, tax is due on your state pension and this will normally be deducted from any private pension or earnings you might have which are paid through the PAYE system.
However if you have no PAYE income, you'll have to complete a self-assessment tax return and pay any tax due directly to HMRC.
Tax on private pensions
Income you receive from private pensions (either directly from an employer's pension scheme or from annuities bought with your pension funds) is paid with tax already deducted via PAYE.
Your tax office sends your pension provider(s) your tax code so it knows how much to deduct, but it's always advisable to make sure you receive a copy of the code for each source of PAYE income to check your tax.
If you do not receive copies of all the codes, or do not understand how your tax is being calculated, contact HMRC.
Tax and purchased life annuities
Just like ordinary annuities bought with pension fund money, purchased life annuities are insurance products that you can buy with a cash lump sum and they pay an income for life. But you can buy them at any time, and the tax treatment of purchased life annuities is different from the tax on an annuity you buy with your pension fund.
Part of the income you receive is treated as a return of your capital, and is tax-free. The rest is paid with tax of 20% already deducted.
- Which? tax calculator- check your 2015-16 tax bill with our tax calculator
- Company pension schemes- find out more about workplace pensions
- Which? Money Helpline- our experts answer your tax queries
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