At the beginning of April, we asked Informed Financial Planning’s Chartered Financial Planner, John Copsey, to write his own article relating to the new pension freedoms (which you can find here). This time, we have asked our Financial Planner, Joe Sanders, to comment on the taxation regarding the newly implemented Flexible Access Drawdown. Read it here…
Flexible Access Drawdown – What tax do I pay?
As many of you will be aware, we have now entered the period where pension access rules have been relaxed. As long as you are over age 55 with a pension fund, you are able to draw 25% as a tax free lump sum and draw the rest of the fund subject to your marginal rate of income tax.
For many people, this offers an exciting opportunity to withdraw a lump sum from their pension fund to spend as they desire. One thing we would urge people to consider however, is how this withdrawal may affect their overall income in retirement. In addition, what may not be clear is how you will initially be taxed on larger withdrawals.
In most circumstances, unless a P45 for the current tax year is available, the scheme administrator will initially deduct tax from your income withdrawal using an emergency tax code on a month 1 basis. This could result in a large initial tax deduction that must then be reclaimed from HMRC.
An example of this is someone who has no earnings for the year and therefore wants to draw £10,600.00 from his pension fund, as income under Flexible Access Drawdown, to utilise his personal allowance for this tax year. Whilst the member should pay no tax on this withdrawal, emergency tax will be applied initially and if the payment is made in April tax of £3,710.25 is likely to be deducted. This will result in a net payment of £6,889.75. The initial tax deducted will reduce depending on when the income payment is made within the tax year, the earlier the payment is made the higher the initial tax charge.
HMRC have released three forms that will allow tax to be reclaimed once the payment is made, rather than having to wait until the end of the tax year. The estimated time frame that HMRC are quoting is 30 days from the date the form has been received. Whilst the HMRC have made it easier to reclaim any tax initially deducted, I think the complications that may be caused highlight the necessity to seek advice when considering drawing income via Flexible Access Drawdown.
This article was originally published on 29/04/2015. Taxation reliefs, levels and bases can change in the future and the content of the article refers to our understanding of taxation legislation at the date shown. Tax is dependent on your own personal situation and circumstances and is subject to change based on UK legislation and taxation regime.
Author – Joe Sanders
Joe joined Informed Financial Planning as a Research Analyst in August 2011 as part of our graduate trainee programme. Joe’s hardworking attitude and ability to work well within the team has already allowed him to become an important part of the company. Joe currently holds the Regulated Diploma in Financial Planning and as part of our graduate trainee programme, has recently been authorised to provide financial advice on the full spectrum of financial planning needs.