Don’t miss out on a Pension Tax Break

After deferring your state pension for a few years you decided that it’s now time to take it. You have the option of a higher pension or a lump sum. The latter offers the chance of some tax planning. What’s involved?

Deferred state pension

As you may know, the government allows you to defer your state pension by up to five years. In return it will pay you at a higher rate when you start drawing it. The position is more advantageous if you reached state pension age (SPA) before 6th April 2016. Not only is the increase in pension almost double that for those who reached SPA on or after the 2016 date, but you can instead opt for a lump sum payment.

More pension or lump sum

Where you have the option of a higher pension or a lump sum you’ll want to weigh up which will be worth more to you. We can’t help you decide other than to tell you that you’ll obtain an extra 10.4% for each whole year you defer your pension. Alternatively, you can take a lump sum equal to the pension you would have received had you not deferred it, plus 2% for each year of the deferral. The pension and the lump sum are taxed differently.

Tax loophole

The state pension and the extra you receive for deferral are simply added to your taxable income. However, if you opt for the lump sum, the rate of tax which applies is whatever the highest rate of tax is on your other income.

Note: Only the main income tax rates apply to state pension lump sums, i.e. nil tax, 20%, 40% and 45% (or the equivalent Scottish tax rates). The special rates of tax for dividends, i.e. 0%, 7.5%, 32.5% and 38.1% are ignored.

Tip 1: If you can plan your income to achieve a nil tax rate on your other income you can receive the whole pension lump sum tax free.

Tip 2: You can choose to receive the pension lump sum in the year following that in which you stop deferring your pension. This allows more time to plan your income.

Number crunching: Getting the numbers right is critical to minimising tax on a state pension lump sum. So when planning income, double check your figures to make sure that you don’t miss anything.

To summarise, the rate of tax on a lump sum (only available if you reached state pension age before 6 April 2016) is equal to the highest rate payable on your income. If you can manipulate your income to achieve a low tax rate, this will save you tax. It’s even possible to make the lump sum completely tax free.

For more information, we provide a Business Consultation to ensure our clients benefits from tax planning and accounting matters.

Companies999 are Chartered Certified Accountants and Birmingham’s Best Company Formation Agent.

For any assistance contact Companies999, we will be happy to help you!

Pension Rules and Rates Explained

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