The scenario: ‘I’m 55 and looking into my plans for retirement. I want to cash in part of my defined contribution pension pot worth £60,000 but I’m confused about tax. How much can I take out of my pension pot tax-free and how much tax will I pay on the rest?’ Pensions are taxable income, however special rules mean you can usually take up to 25 per cent of your pension pot tax-free. You can take your 25 per cent tax-free lump sum out of your pension in one go. For your pension pot of £60,000, if you take a 25 per cent tax-free lump sum you’ll get £15,000 tax-free.
For the other £45,000, you’ll need to buy an annuity or drawdown product, which is subject to tax. If you don’t want to take your 25 per cent tax-free lump sum in one go, another option is to take multiple cash lump sums (UFPLS), rather than buying an annuity or a drawdown product. If you do this, you will get 25 per cent tax-free of each lump sum. For example, if you were to take £1,000 per month out of your pension, £250 would be tax-free. The remaining £750 is taxable. How much tax you pay on the rest of your pension will depend on how much you “earn” in any one tax year. This includes your state pension and some earnings from investments, such as property or savings.
If your total income is less than your personal allowance of £11,000, you won’t pay any tax. If it is above £11,000 you’ll be taxed at 20, 40 or 45 per cent as usual. Don’t rush into any decisions and find out more at www.pensionwise.gov.uk. Citizens Advice Derbyshire Districts offers free, confidential and independent advice on any subject. Visit the office in Bank Road, Matlock, from 10am to 4pm weekdays, or call 0844 375 2712.