Pensions and tax
Other times when you might get a tax charge
While pensions are a tax-efficient form of saving, there are events that may arise that can trigger a tax charge. Below are some explanations about other times when you may incur a tax charge.
Trivial pensions and small pots
If you have defined benefits where the total value of these do not exceed £30,000 in total and you are aged 55 or over, or retiring earlier because of ill-health you may be able to take the whole of your benefit as a one-off cash lump sum. You can normally take up to 25% of your pension value as a tax-free cash lump sum (called a pension commencement lump sum (PCLS)) and the remainder will be taxed as if you had received it as income in the tax year that you withdraw it. In some circumstances, if you have a small pension in payment, you may also be able to commute this for cash on triviality grounds.
In order to value your pension to test to see if it qualifies for trivial commutation, you need to multiply the value of your pension built up in the scheme by a factor of 20.
Due to the new flexible rules for defined contribution schemes, trivial commutation now only applies to defined benefit schemes. Similarly, if you have small pension pots, worth up to £10,000 each, and you’re aged 55 or over or retiring earlier because of ill-health you may be able to withdraw the whole pot as a one-off cash lump sum. You can withdraw up to three separate pension pots worth up to £10,000 in this way.
In each of the above cases, you must withdraw the whole of your pension in the scheme(s)– you can’t retain any retirement benefits
Your workplace scheme is wound up
If your employer decides they no longer want, or can no longer afford to pay contributions, your workplace pension may be wound up. If this happens and the value of your benefits under the scheme is no more than £18,000, you may be able to take your benefits as a one-off cash lump sum.
If you've not started to draw retirement benefits from the scheme, you should be able to receive up to 25% of the cash lump sum tax-free as a PCLS, with the remainder taxed as income in the year that you receive it.,
If your pension is already in payment, the cash sum that you receive, in lieu of your pension, is taxed as income in the year that you receive it.
Uncrystallised Funds Pension Lump Sum (UFPLS)
There are no restrictions on the amount of your pension pot that can be withdrawn as a cash lump sum if you are a member of a defined contribution pension scheme. Again, only 25% can be withdrawn tax-free as a PCLS with the remainder taxed as income. Taking the remainder of your pot as income in one go could push you into a higher rate tax bracket.
If this is the case, you may have the opportunity to spread taking the money out over two (or more) tax years. If you’re a member of a defined benefit pension scheme, this new flexibility will not be available to you.
Lump sums paid on your death
1. Before you start drawing benefits
If you die before you start drawing benefits from your pension scheme and are aged less than 75, any cash lump sums are normally paid free of tax. This is providing that they are paid at the discretion of the trustees or pension provider and the lump sum is paid within two years of the pension scheme being told about your death. If you are aged over 75 and haven’t started drawing benefits when you die, cash lump sum payments will be taxed at 45% for any payment in the 2015/16 tax year and then at the recipient’s marginal rate of income tax for any lump sum payment made in the tax years 2016/17 onwards.
2. After you start drawing benefits
If you die before age 75 with a remaining income drawdown fund, any lump sum, or income payments to beneficiaries, will be paid tax-free.
If you die after age 75 with a remaining income drawdown fund, any lump sum payment will be taxed at 45% for any payment in the 2015/16 tax year and then at the recipient’s marginal rate of income tax after that.
Serious ill health lump sum
If you fall seriously ill, and are unable to work and it’s expected that you will continue to be unable to work before your retirement age or your expectation of life is less than twelve months, you may be able to draw your pension early as a one-off serious ill-health lump sum payment, regardless of how old you are.
If a serious ill-health lump sum is paid before age 75, this is paid tax free. If a serious ill-health lump sum is paid after 75, there is a tax charge of 55%.
A serious ill-health lump sum cannot be paid if you are already drawing your pension.
A registered medical practitioner must confirm in writing to your pension scheme that in their opinion, your expectation of life is less than twelve months or that you will be unable to work again before your retirement age.
Refund of contributions
If you’re a member of a defined benefit or money purchase workplace pension scheme and you leave your job after less than two years qualifying service (qualifying service may be service with your employer or service in the scheme, if less), you may be offered the option to receive a refund of the contributions, or the value of your money purchase fund bought by your own contributions, that you have paid into the scheme.
You will pay a tax on any refund, with the first £20,000 taxed at 20% and any amount above £20,000 taxed at 50%. This tax will be deducted by the scheme administrator before the refund is paid to you, and paid across to HMRC on your behalf. The rates of tax reflect the fact that you will have received tax relief when you paid contributions into the scheme.
You can’t reclaim the tax that is deducted by the scheme administrator, but the sum paid to you is not liable to further tax.
Where can I find out more?
If you need more information, please contact us. A pension specialist from our team will be happy to help with whatever pensions-related question you have. Our help is always free.