Pension pots-Lump sum or annual income?



From April this year the new pension reforms mean that those aged 55 or over will have a choice of how they take money from their pension pot with 25% being tax-free, but what does this actually mean to individuals and how does it benefit them?

Those who have saved a relatively large pension pot could use the new reforms to avoid paying 40% tax when they draw it down. For example, let’s say you had £150,000 in your pension pot and decide to cash the lot in April. £37500 would be tax free, but the remaining £112500 would be taxable. So depending on your personal allowances you could pay more than £40,000 in tax. However, by taking the money as an annual pension each year, lets say for four years @ £37500 per year, then you would get £9375 tax free and only pay tax on £28125. This could mean paying only around £4500 tax which over four years equates to about £18000, 22k less than the first option.

Those with less in their pension pots won’t save as much but it’s still worth doing the same. For example, the average pension pot for individuals who have defined contribution schemes is about 45k. Taking it all means an £11250 tax-free cash amount and the remainder being taxed, which would leave about 28.5k. Take the cash as a pension over four years@ £11250 per year and you’d receive £2812.50 tax free with the remaining £8437.50 liable for tax. But bearing in mind that the personal allowance is 10k per year before you pay tax, it means that the remaining 8.4k would not be taxable giving you a tax free pension. It’s worth remembering however that if you are receiving your state pension as well HMRC will include this when doing their calculations for tax. You do not need to draw your state pension and are able to defer this for a number of years if you want to.

Everyone’s needs are going to differ in retirement which is why we would advise individuals to have an independent financial and pension review to ensure your financial requirements will be met and any concerns or unanswered questions can be discussed.

The value of pension and the income they produce can fall as well as rise. You may get back less than you invested.

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