My wife is cashing a small pension and will breach the £12,500 income tax threshold – can she avoid a tax bill? Steve Webb replies
My wife is 70 in May. A small pension she set up whilst working is about to mature this year. The total amount is £10,000.
Because she already receives her state pension plus another from her deceased ex-husband, she has used approximately £7,000 of her £12,500 tax allowance limit for the year.
This would mean if she took the money, minus the 25 per cent tax free lump, she is still liable for tax.
Retirement finances: My wife is cashing a small pension and will breach the £12,500 income tax threshold – can she avoid a tax bill? (Stock image)
This seems very unfair as every other year before this and after she will earn a lot under the limit.
Is there not a special dispensation allowing her to share the excess over several tax years?
SCROLL DOWN TO FIND OUT HOW TO ASK STEVE YOUR PENSION QUESTION
Steve Webb replies: As you rightly say, when you take money out of a pension pot the whole withdrawal is counted for tax purposes in the year in which you take the money out.
If your wife empties out her pot in one go, taking 25 per cent as tax-free cash, the remaining £7,500 would be added to her £7,000 income and this would take her above the £12,500 personal allowance, giving her a tax bill in that year.
Steve Webb: Find out how to ask the former Pensions Minister a question about your retirement savings in the box below
There are however a few ways in which she could phase taking the money out which would mean that she would pay less tax, or possibly no tax at all.
The first option would be to use the remaining £7,500 to buy an income for life or an ‘annuity’.
With such a small pot she probably would not get much in the way of an annual income, but that annual income would be paid each year for as long as she lived.
Given that this would probably be only a few hundred pounds a year on top of her existing pension she would still be under the tax threshold and not have to pay any tax.
The second option would be to move the pension pot into an income drawdown policy and then to take the money out in chunks over a number of tax years.
She may however find that with such a relatively small pot, not all drawdown providers would be willing to open a policy for her.
There are two main sorts of drawdown policy.
The first is known as ‘flexi-access’ drawdown. With this sort of policy, your wife could take her 25 per cent tax free at once and then the balance would be invested in a drawdown account.
Money taken out of the drawdown account would be taxed as income in the year that it was withdrawn.
Using the figures that you have supplied, one option would be for your wife to take half of the £7,500 in one year and half in the next.
Even adding this to her other pension would keep her below the tax threshold.
The second type of drawdown allows you to move the whole £10,000 pot across and then take the money out in ‘chunks’.
One quarter of each chunk is tax free and the rest would be taxed as income in the year that you take it.
Both of these options would allow your wife to spread her taxable withdrawals over two or more years and thereby keep under the tax threshold.
For an impartial conversation about these options, the best organisation to talk to is the Government’s PensionWise service.
There is a lot of information on their website at pensionwise.gov.uk and you can also arrange a telephone discussion or a face-to-face meeting.
Whilst they won’t give you financial advice, they will explain in more detail how the different options work which should help your wife to decide how she wishes to proceed.
ASK STEVE WEBB A PENSION QUESTION
Former Pensions Minister Steve Webb is This Is Money’s Agony Uncle.
He is ready to answer your questions, whether you are still saving, in the process of stopping work, or juggling your finances in retirement.
Steve left the Department of Work and Pensions after the May 2015 election. He is now a partner at actuary and consulting firm Lane Clark & Peacock.
If you would like to ask Steve a question about pensions, please email him at [email protected].
Steve will do his best to reply to your message in a forthcoming column, but he won’t be able to answer everyone or correspond privately with readers. Nothing in his replies constitutes regulated financial advice. Published questions are sometimes edited for brevity or other reasons.
Please include a daytime contact number with your message – this will be kept confidential and not used for marketing purposes.
If Steve is unable to answer your question, you can also contact The Pensions Advisory Service, a Government-backed organisation which gives free help to the public. TPAS can be found here and its number is 0800 011 3797.
Steve receives many questions about state pension forecasts and COPE – the Contracted Out Pension Equivalent. If you are writing to Steve on this topic, he responds to a typical reader question here. It includes links to Steve’s several earlier columns about state pension forecasts and contracting out, which might be helpful.
If you have a question about state pension top-ups, Steve has written a guide which you can find here.
TOP SIPPS FOR DIY PENSION INVESTORS