Retirement savers are excited at the prospects of Chancellor George Osborne letting them get their hands on their pension cash earlier than expected after his shock Budget 2014 reforms of the financial industry.
But anyone who thinks they will get to keep all the cash in their retirement fund after the new rules come in from April 6, 2015 is in for a surprise.
So here are some answers to the most frequently asked pension tax questions:
How much of my pension can I take tax free?
This depends on what type of pension you have and whether you are a UK tax resident or expat.
A UK onshore pension lets a retirement saver take 25% of the fund as a tax-free lump sum. The saver then pays income tax at their marginal rate on the rest.
A Qualifying Recognised Overseas Pension Schemes (QROPS) allows an expat to take from 25% to 30% tax-free depending on which financial centre runs the pension. Then, they pay income tax at their marginal rate in the country where they live.
What is my marginal rate of income tax?
If you have an income of more than £10,500 a year, you pay tax on your pension at your marginal rate – this is the highest rate you pay tax at.
A basic rate taxpayer’s marginal rate is 20%, a higher rate taxpayer’s marginal rate is 40% and a top rate taxpayer’s marginal rate is 45%.
How much tax will I pay on a £38,000 pension pot?
£38,000 is not a random figure – it’s the average size of a UK pension pot, according to industry trade body the Association of British Insurers.
The tax calculation works like this:
- 25% of the pot is tax free – so that’s £9,500
- Assuming the retirement saver has a state pension of £5,500 a year, they can take another £5,000 without paying income tax.
- That adds up to £14,500 without tax, leaving tax due at your marginal rate on £23,500
- For a basic rate taxpayer, that’s 20% of £23,500, which is £4,700, leaving a fund of £33,300 after tax
For higher and top rate taxpayers the picture is different. They get the same 25% tax free lump sum, but because they pay tax at a higher rate, they won’t have any of their personal allowance left, so they pay tax at a higher marginal rate on more money.
For a higher rate taxpayer, that’s £28,500 x 40% = £11,400 income tax, leaving £26,600 net.
Top rate taxpayers pay a bit more – £28,500 x 45% = £12,825 income tax, leaving £25,175 net.
