Tax in pension drawdown

The April 2015 pension freedoms mean there are no longer restrictions on the level of drawdown income you can choose to take and many people can now withdraw their entire fund as a lump sum should they wish to.

The thought of taking your entire pension pot as a lump sum may initially be very appealing. However, while typically 25% of any sum taken will be tax-free, the remaining 75% will be taxed as income.

This means that you could pay as much as 30% or maybe even more straight to the tax man, depending on the size of your pension pot and any other income you may receive.

Our Tax Calculator can help you estimate how much tax you might pay if you were to withdraw your entire pension pot, or if you would prefer to speak to one of our specialists you can call us on 0800 975 5151.

Tax-efficient Pension Drawdown

For those still tempted to withdraw their entire fund, there may be a more tax-efficient way to do this using Pension Drawdown which can help you to minimise or even avoid any tax bill generated.

Pension Drawdown allows you to spread out your income withdrawals over the coming tax-years, making the most of your tax-free income allowance or staying within a lower tax band.

Tax efficient growth on your pension savings

The investment return you hope to see from your Pension Drawdown plan are mainly free from income tax and capital gains tax.

This means that you may have to pay less of any investment return you achieve to the tax man than if the same growth were seen in a fund held outside of pension plan.

Free from inheritance tax

Pension funds, including those held in Pension Drawdown do not form part of your overall estate on death, so would not be included in any calculation for an inheritance tax bill.

Lower tax to beneficiaries on death

How your beneficiaries will be taxed will depend on your age at death, if you are under 75 then anyone can inherit with no tax to pay.

If you were to die over the age of 75, any income taken from drawdown will be taxed at your beneficiaries’ marginal rate of income tax and any lump sum(s) would be taxed at 45%. From April 2016 the tax payable on any lump sum(s) will be reduced to your beneficiaries’ marginal rate of income tax. Beneficiaries can also ‘manage’ the withdrawals to help control the tax bill.

Tax on income

Any income you take from your Pension Drawdown plan is taxed in the same way as earned income. Pay As You Earn (PAYE) tax will be deducted from your pension income before it is paid to you, subject to receipt of the correct tax code information from the HMRC.

Remember, you will have received tax relief when you made the original payments into your pension plan.

The main benefit of drawdown is that you can control the size and timing of your withdrawal in line with what works best for your own tax position. For example, only withdrawing enough to keep you inside the personal allowance or inside the 20% tax band therefore minimising any tax you pay.

All of the information that we provide is based on our understanding of current tax and pension rules, which can change.