Pensions’ flexibility; but with a warning!

NOTE: This post is more than 12 months old, and the information contained within may no longer be accurate.

The 6th April 2015, “Lamborghini” Day trumpeted access to defined contribution pension plans without restriction.  In most instances there is access to 25% tax free cash with the balance subject to income tax.  This raises the question as to how ad hoc or one off withdrawals are taxed if you want to dip into your pension savings to fund a holiday, replace your car, make home improvements etc.  Convention would suggest that you would be taxed at your marginal rate of income tax or if your provider has a tax coding that this will be applied.  Unfortunately, in almost all instances, an ad hoc or one off payment will trigger an emergency tax coding.  What does this mean?  Your pension provider or administrator will apply what is known as a month 1 code.  This means your income tax liability is calculated using 1/12th of your Personal Annual Allowance in conjunction with the monthly tax bands.  The example below illustrates how taking £40,000 from your pension fund is likely to be taxed:

John takes (crystallises) £40,000 from his SIPP.  £10,000 is his tax free cash entitlement.  £30,000 he takes under flexiaccess drawdown.  An emergency tax code is applied to the ad hoc of £30,000

Tax Band Amount Rate of tax Tax
Personal Allowance £883.33 (£10,600 / 12) 0% £0
Basic rate £2,648.75 (£31,785 / 12) 20% £529.75
Higher rate £9,851.25 (£150,000 – £31,785) / 12 40% £3,940.50
Additional rate £16,616.67 (the balance) 45% £7,477.50
Total = £30,000 Total = £11,947.75

This results in the pension income being taxed at a rate of 39.82% (£11,947.75 / £30,000).  So of the £40,000 that John crystallised, he actually receives the net amount of £28,052.25.

As almost always an overpayment of income tax will have occurred, a reclaim can be requested from HMRC.  Forms P50Z, P53Z or P55 will facilitate a reclaim depending on your circumstances.

As with most financial planning it makes sense to be aware of the wider implications of a course of action before that course of action is taken.  Generally speaking, we would not consider taking large one off payments under Flexi Access Drawdown to be a particularly sensible way to draw on taxable pension income.

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