How taking a pension lump sum could save you money

24th February 2020

 

If you reached state pension age after 6 April 2016 and deferred taking your pension, you will receive a higher weekly amount when you start receiving it.

However, if you reached state pension age before 6 April 2016 there is a second option, which is to receive a state pension lump sum rather than the additional weekly payments.

How is the lump sum taxed?

Barry (72) reached state pension age a few years ago and therefore could have started to receive his pension before 6 April 2016.   However, as he was in business at the time he decided to defer it.

Barry started to receive his state pension in 2018/19 and chose to receive a lump sum, which was £30,000.

In example 1 Barry was a higher rate taxpayer before considering the state pension lump sum, therefore 40% tax was payable – £12,000 in total.

In example 2, Barry received a smaller dividend from his company. His total income is less than the basic rate limit, so you may expect 20% tax to be payable on a proportion of the lump sum, with the remainder being taxed at 40%.  However, this is not the case. Due to the way this piece of legislation works, 20% tax would in fact be payable on the entirety.

In summary, take your state pension lump sum in a tax year where your other income is lower, if at all possible.  If Barry had spoken to his adviser before taking the lump sum, it may have been possible to save £6,000 in tax.

Pension contributions and gift aid donations can be used to reduce the tax to a lower rate.  It is also possible to carry back gift aid donations made after the end of the tax year in question (as long as the donations are made before your tax return for that year is submitted to HMRC) giving even more options to reduce the tax.

Further detail can be found here: https://www.gov.uk/deferring-state-pension/what-you-get. If you are looking to take a state pension lump sum, please speak to your usual Whiting and Partners contact for advice before doing so – it could save you thousands!

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