Tax and the cash lump sum
When you draw benefits from your pension scheme, you can normally receive some of the benefit as a tax-free cash lump sum.
Pension Commencement Lump Sum (PCLS)
When you can start drawing benefits from your pension scheme, you may be able to take part or all of your pension benefits as a tax-free cash lump sum (called the pension commencement lump sum (PCLS)). If you’re a member of a defined benefit pension scheme, the scheme’s rules will determine how much you can receive as a PCLS. If you’re a member of a defined contribution (DC) pension scheme, you will normally have the option to take up to 25% of the value of your pension pot as a PCLS.
In certain circumstances, some people may be able to receive more than this. If the value of your pension pot exceeds the lifetime allowance when you draw retirement benefits, the amount of PCLS that you can receive is normally limited to 25% of the lifetime allowance. You may be able to receive a PCLS in excess of 25% of the lifetime allowance if you have applied to HMRC for either scheme specific lump sum protection or one of enhanced protection, fixed protection or primary protection in a year when the lifetime allowance has reduced. Different terms and conditions apply to each of these protections.
The cash lump sum (PCLS) and tax
Any amount that you take as a PCLS is free of all taxes when it is paid to you. Members of defined contribution pension schemes have complete flexibility around how they can draw down their remaining pension pot after taking any PCLS, but these amounts withdrawn will be taxed as income.
It’s important to check whether these taxable lump sums push you into a higher tax bracket (40% or higher). In some circumstances, if you withdraw the whole, or a large part, of your pot, after taking PCLS, in a particular tax year, the marginal rate of income tax on some of your income could be as high as 45% (or even higher).
It’s also important to note that the flexibilities that came into effect in April 2015 do not apply to members of defined benefit pension schemes.
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.