How will a work pension pot worth £9,000 be taxed when I retire? I’m being given confusing advice: Steve Webb replies

I have a small working pension of around £9,000. I am 61 years old and I am retiring at the end of March.

Today I called my pension firm who told me that if I increase my pension to £10,000 I can receive £2,500 over the next four years and all of this will be tax-deductible as it falls on different tax years.

I then spoke to Pension Wise, who informed me that this information was incorrect and that only the first 25 percent was tax-free. Could you advise please.

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Steve Webb replied: I can understand why you were confused by the apparently conflicting information you were given. I hope I can clarify what’s going on.

As Pension Wise told you, when you turn 55, the basic idea is that a quarter of your pension basket can be tax-exempt and the rest count towards your taxable income in the year you receive it.

This means that if you wish to receive a pension basket of £10,000 at one time, you will receive £2,500 tax-free and the remaining £7,500 will be treated as taxable income for that year.

However, the actual amount of tax you pay will depend on what other income you received in the same year.

For example, you mention that you are currently working. If you use up your pension basket this year, £7,500 will be added to your salary and you can easily pay tax on the entire amount.

However, your ISP suggests that you do something different.

Instead of taking all the money at once, you should wait until you retire and then take “pieces”, with each piece not being taxed at 25% but potentially being taxed at 75%.

Since you are retired (so you didn’t have a taxable wage) and you’re under retirement age (so you didn’t have a taxable state pension), then 75 percent would be within your tax-free income. personal permission.

So, although this portion of your withdrawal is included in your taxable income, you will not actually pay any taxes because it will be fully covered by your personal benefit.

However, there are a few more things to think about.

First, think about what you, in fact, will live on if you quit your job and did not start receiving a state pension.

It seems unlikely that you could live on a £10,000 pension basket spread over four years.

If you have other income (such as an occupational pension or property rental income), this could eat into your personal allowance for the year and mean that your private pension portions will exceed the tax-free allowance and be taxed eventually.

The second interesting thing is that your provider has offered to increase your pension to £10,000.

Not to mention that they were a bit close to giving you financial advice, I was surprised at first that they tied the possibility of getting a pension in installments to the amount you had in the bank.

However, I checked your provider’s website and they say the minimum bank size you must have before you can receive your pension in ‘flex units’ is £10,000 and so they offered you top up your account before you can go down this path.

One final practical point to keep in mind is that on your first withdrawal, HMRC may ask your ISP to deduct tax using an “emergency” tax code.

HMRC does this because they think you can withdraw a lot of funds, which will clearly result in you being over the tax threshold. But if you plan to withdraw funds only once a year, you can fill out the form and receive a tax refund from HMRC.

You should also be aware that once you start taking taxable money out of a £10,000 or more basket, you will activate a tighter cap on the tax credits you can receive on any future retirement savings.

If you don’t plan to save more for your retirement in the future, this shouldn’t bother you, but if there’s a chance you can go back to work and pay your pension again, you should be aware of it.

I wrote more about this “Annual Money Purchase Allowance” here.