How much you could lose in taxes by cashing in under new pension rules

The new pension rules took effect in April and more than £1 billion of pension savings have been cashed in so far. A percentage of those savings has gone straight to the taxman – but not everyone knows about the tax rules and implications of cashing in their funds. 

The reality is that many people are unaware of the tax bill they could face when taking money under the new pension rules. Previous research found that 85% of people were unaware that they could face an income tax bill when withdrawing a cash lump sum from their pension. 

The money you withdraw from a pension is considered as taxable income on top of any income you already have that year, so it is possible that you could be pushed into a higher income tax bracket and lose a large amount of your hard-earned savings in taxes. 
The table below shows the current income tax rates and thresholds:

Tax rate Taxable income above your Personal Allowance
Basic rate 20% £0 to £31,785 
People with the standard Personal Allowance start paying this rate on income over £10,600
Higher rate 40% £31,786 to £150,000
People with the standard Personal Allowance start paying this rate on income over £42,385
Additional rate 45% Over £150,000


The pension tax rules

Since the new pension rules were introduced in April 2015 it has been possible for people aged 55 and over to access their entire pension fund. Up to 25% can be taken as a tax-free cash lump sum, and the remaining 75% is subject to income tax. 

The amount of tax to be paid is dependent on your individual circumstances, including how much you withdraw and total earnings for the year.

How much tax you could pay

It is possible to make tax-efficient withdrawals by being strategic when releasing cash from your pension. 

If you empty your entire pension pot as one cash lump sum you are likely to lose a larger portion of your savings to the taxman because you will have more taxable income. Earnings over £42,385 are taxed at the higher rate of 40% and earnings over £150,000 are taxed at the additional rate of 45%. If your income for the year is more than £100,000 you will begin to lose your personal allowance and from £121,200 it will be lost altogether.

On the other hand, if you withdraw several smaller amounts of money over different tax years you could significantly reduce your tax bill and therefore keep hold of more of your savings.

Example scenario 1: Emptying the entire fund 

  • Pat is 58 and has a pension value of £250,000
  • He earns a salary of £26,000
  • He takes his 25% tax-free cash of £62,500
  • He wants to withdraw the remaining £187,500 to invest in property and help his daughter pay a mortgage deposit
  • His taxable income for the year is £213,500, so Pat loses his personal allowance
  • His tax bill is £82,218, almost a third of his total pension value.

Example scenario 2: Withdrawing several smaller amounts over time

  • Pat takes his tax-free cash of £62,500
  • He withdraws the remaining £187,500 as three lump sums of £62,500 over the course of three years
  • His taxable income for each of the three years is £88,500, so Pat keeps his personal allowance
  • His tax bill for each of the three years is £24,799, which amounts to a total of £74,397

That’s a tax saving of £7,821 in comparison to scenario 1!

This shows just how important it is to be aware of the tax rules and how much tax you could end up paying if you cash in your pension. 

Before making such an important financial decision you should consider why you want to cash in your fund.  For example if you plan to invest in property there are other taxes and fees you’ll need to pay, despite having already paid tax when cashing in your pension. These include:

  • Stamp duty
  • Capital gains tax on growth if the property is not your main residence
  • Income tax on any rent payments you receive
  • Legal fees 

Investing in property may not be the best option for you as your money will be invested in just one place, which is not advised as it carries greater risk. In addition to this the value of your property will need to increase significantly to cover the tax you’ve paid before you can begin to make a profit.    

It is often more effective to leave your savings in the wrapper of a pension, where they can continue to grow and be used as a source of retirement income. Pensions provide many benefits, including: 

  • Tax relief on contributions
  • Tax-free growth on investments
  • Up to 25% tax-free cash from the age of 55
  • Employer contributions to boost your workplace pension savings

    It is important to explore all of the options available to you and speak to a regulated financial adviser for impartial advice on what option is best for your individual circumstances. If you’d like to find out more about cashing in your pension take a look at our factsheet.

Call 0800 304 7288 for a friendly chat about your pension

The details provided in this article are for general information only and are in no way deemed to be financial advice. All of the material is correct as of the publication date, but could be out-of-date by the time you read the article. For our latest information and news, please see our articles section:

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