Pension UK: How to reduce your tax costs through withdrawal plans and redundancy payments


Pension assets can be complicated and managing them can be incredibly difficult, especially when it comes to tax and withdrawals. Fortunately, new advice has emerged on how withdrawals can be made without triggering huge tax bills and how redundancy payments could be used to help a retirement.

Taking a quarter of your pension savings tax free

Many people are likely aware they can take up to 25 percent of their pension pots tax free, but what they may not know is how this can be done in practice.

Modern pension plans tend to be flexible in nature which can provide savers with options on this, as John explained: “When you access your pension savings, you can normally take 25 percent tax free. If you have a modern, flexible pension plan, when you take this is up to you.

“You can take it in slices over a number of years if the pension plan you have lets you.

“This is known as phasing and could be a smart move as it tends to be more tax efficient overall.

“You could take it all at once, however, just because you can doesn’t mean you should.

“The longer your money stays untouched inside your pension plan, the more potential it has to grow in a tax-efficient way and the higher your tax-free amount could be.

“Of course, that’s not guaranteed and because money in your pension is invested, its value can go down as well as up and could be worth less than what’s been paid in.”

As John continued, he broke down the relationship between income levels and pension assets.

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How you take your money can make a real difference

Pension income can be counted as taxable income, meaning a certain amount of maths will need to be done to ensure the right decision is made.

The right amount will vary from person to person, but John broke down how the calculations could be applicable: “Most people will have a personal income tax allowance that means they don’t have to pay tax on the first £12,500 of their income (for the year 2020/21), such as salary or rental income. However, if your yearly income is over £100,000, you may not get this personal allowance.

“When you take money from your pension savings over the tax free limit, it’s taxable just like any other income – as is the State Pension, when it kicks in.

“That means you pay income tax on anything above your tax-free cash and any personal allowance you get every year.

“How much income tax you pay will depend on which tax band your income falls into. By taking just enough to keep in the lowest tax band you can, you could keep more of your money overall.”

Embracing this “just enough” ethos could pay real dividends in the long term, as John went on to focus on the benefits of financial restraint.

The potential benefit of little and often

Retirement plans can take many forms but they can all be hindered by over-enthusiasm, as John called for savers to keep a level head when reaching their later years: “Whatever your plans for life after 55, whether that’s to continue working, work less, set up your own business, or travel, taking out just what you need and leaving the rest in your pension plan until you need it could be a clever move for many people.

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“This is because you’re keeping your money invested with the potential for growth.

“Taking out more than you need and putting it in a current or low-interest savings account, for example, means you lose that potential for growth, and as costs rise with inflation this means you can afford to buy less with your savings.”

Of course, in the current environment, pension plans of all shapes and sizes have likely been upended by coronavirus and its effects on the economy.

In the coming months thousands of employees may find themselves being made redundant as government support reduces and this could be particularly difficult for older workers.

Realising a retirement, which was originally just around the corners, is now up in the air can be a scary position to find oneself in but taking a step back and evaluating what’s going on is always a good idea.

Think about how much you’ll actually need in retirement

This can sound like a daunting task but fortunately, free-to-use tools can help with these reviews, as John highlighted: “It’s a good idea to start by estimating your annual cost of living. Future expenses are hard to predict, but to get a ballpark figure take your current outgoings and then subtract any expenses you expect to no longer have (e.g. a mortgage) and add in any new ones (e.g. travel plans or a dream car).

“To compare that against how much you might need, The Pensions and Lifetime Savings Association (PLSA) has developed a handy Retirement Living Standards resource that gives you an idea of the savings you might need.

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“Alternatively, a financial adviser can work with you to calculate how much money you are likely to need for the whole of your retirement.”

On the other side of redundancy pessimism, some savers may be able to take their package and completely reverse their fortunes.

How to maximise your redundancy pay

Tax costs can once again be reduced here if certain actions are taken, as John concluded: “Redundancy pay is compensation for your job loss and qualifies for special tax treatment, with the first £30,000 payable tax free.

“If you receive a payment of more than £30,000 or receive a payment in lieu of notice, this would normally be subject to tax at your marginal rate. You may be able to avoid paying tax on this amount by paying it into a pension instead.

“For example, if you are a member of your employer’s pension scheme, you could ask your employer to pay the excess above £30,000 directly into your pension for you. The boost to your pension could be worth nearly double the net amount you’d get if you took the bonus as cash.

“It will also give you more tax efficient planning options for the future – a well-earned and perfectly timed added extra to that pension pot just before you head into retirement.”





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