How to Avoid Paying Hefty Pension Freedom Tax Bills in April

by Michele Carby | | Pensions , Tax

Tips for Good Pension Freedom Management

When Pension Freedom comes into play in April, there is a strong possibility you could be hit with unexpected tax bills. Under Pension Freedom, and depending on your pension provider policy, you can have unfettered access to your pension pot. You can withdraw the whole lot if you want to. Every financial planner on the planet however, will advise against this course of action, due to the hefty tax bill that would incur.

It is not just this scenario which could invoke a tax shock. As such here are some tips to avoid a big bill from the taxman.

How do I avoid big pension tax bills?

Understanding tax rates in retirement

To get a handle on Pension Freedom tax, you need to understand how much you will be taxed in relation to your income. So:

  • Incomes of less than £10,000 per year are classed as personal allowance which is untaxed. This may be stretched to £10,660 depending on your age.
  • Once the personal allowance threshold is broken, your tax rate will be 20% until you reach £31,865 per year.
  • If you exceed this threshold, you will be taxed at 40%. Should your income exceed £150,000 per year, you will pay the highest tax bracket at 45%.

If you are unfamiliar at paying your own tax, you may find this to be a little complicated. Tax in relation to Pension Freedom becomes more complicated when you factor in the following:

  • The first 25% or £6000 is tax free. So this will offset the amount of tax you have to pay.
  • There will be forms to complete.
  • Other incomes will be a factor as well. For example, should you receive rental income; this together with your pension income for the year will be taken into account for tax. If you are unfamiliar with tax liabilities, this could be quite a shock.

Should I Withdraw my Entire Pension Pot in the First Instance?

This would be a terrible idea. Here, you would see a sizeable chunk; almost half of it disappears to the taxman. To avoid paying a massive tax bill, withdraw your pension in smaller amounts, keeping under the tax thresholds when all your income for the tax year is taken into account. Ideally, you want to try and limit your income, so the tax rate you pay is 20% or under.

Will I have to Complete Tax Forms for Pension Freedom?

Unless you want to wait until the end of the tax year, the answer is almost certainly yes. Should you withdraw £24,000 in April for example, £6000 will not be counted for tax purposes. The remaining £18,000 will be taxed at 40%, as it will be assumed you will be withdrawing £24,000 every month even if your pension pot is not that large. As such, your pension provider will probably give HMRC £6,600 (40% of the £18,000).

To reclaim your tax, you will need to complete one of these forms:

  • P50 if your only additional source of income is your state pension
  • P53 if your tax affairs are more complex such as additional forms of income

If you decide not to complete these forms, HMRC should refund any overpayment of tax to you at the end of the year.

Pension Freedom Minefield

As you can tell this is a bit of a minefield. It is easy to make mistakes with Pension Freedom, and recent surveys highlighted that many unfamiliar with tax liabilities were going to withdraw their whole pension pot come April. A massive mistake.

To avoid making similar errors, and to claim your tax back faster and in turn have a better quality of life, talk to me and we can go through your incomes, and look at ways to minimise your tax burdens. In essence I can make Pension Freedom work for you. Click here now.

For more information, please contact Michele Carby at Holborn Asset Management on +971 50 618 6463 and on e-mail at [email protected]