Text size:

Tax implication case studies

Our tax implication case studies are here to help you to gain a better understanding of some of the tax implications you should consider when thinking about taking your pension savings as a cash lump sum.

Find out what to do if you have overpaid on your tax when taking your individual pension savings as cash.

Susan, a part time doctor’s receptionist from Bristol, had just turned 55 and was thinking about taking her pension early, even though she wanted to carry on working in her £10,000 a year job.

One of the deciding factors was that her daughter was just about to go to university and Susan thought she’d take the whole pension fund of £25,000 as a cash sum and put it towards her daughter’s fees.

She talked to her pension provider who explained that 25% of the cash sum (£6,250) would be tax free, but based on HM Revenue & Customs (HMRC) regulations they would have to apply an emergency tax rate on the remaining amount of £18,750 With emergency tax applied, this meant that Susan would receive £18,134 directly from her pension provider so would be paying £6,866 in tax on her £25,000 pension fund.

Her pension provider went on to explain that whilst an emergency tax rate would be applied initially, this would not be Susan’s final tax year-end position and advised that she should contact HMRC to check whether she would overpay on her tax for the year.

Susan contacted HMRC and they advised that when taking all of her yearly income into account (£10,000 from her job and the £25,000 lump sum from her pension fund), Susan’s yearly income would be taxed using 20% basic rate tax.

This meant that Susan would therefore be due an overall tax refund.

Please see below for a breakdown on Susan’s final tax year-end position.

Susan’s year-end tax position including £25,000 pension fund withdrawal:

£10,000 income earnings + £18,750 (£25,000 – 25% tax free amount) = £28,750

£28,750 – Personal allowance of £11,000 = £17,750

Total year-end tax due, £17,750 @ 20% = £3,550

As emergency rate tax would be applied to Susan’s pension fund withdrawal, she would pay £6,866 in tax. However, when taking all of her income into account (salary + pension fund withdrawal), Susan would in fact only be due to pay £3,550 in tax. Susan would therefore be entitled an overall tax refund of £3,316

How would Susan claim her tax refund?

She could either wait until after the end of the tax year when HMRC will automatically assess the tax she has paid and contact her with a relevant refund payment. Alternatively she could complete the relevant form detailed below which can be found on the GOV.UK website or contact HMRC on 0300 200 3300.

Form P53Z if you have other sources of income

This case study is a fictional representation of people’s experiences and is for illustration only. It is based on an individual pension policy. Everyone’s circumstances are different and your personal circumstances, however similar to the case study, need to be taken into account when reviewing your pension. This case study does not constitute tax advice or advice or guidance regarding your pension and you should seek pension guidance before making any decision.

Personal allowance and tax rates used are based upon rates for 2016/2017

Could taking a full lump sum from your individual pension savings push you into a higher tax bracket?

When care home manager John was nearing his 60th birthday, he thought about taking his full pension fund as a cash lump sum of £25,000 to treat himself and his wife to a luxury holiday, as well as using some of the cash to pay for improvements around the house.

He was still working, with an income of £40,000 a year, and his pension provider explained that 25% of his £25,000 pension fund would be tax free (£6,250) but based on HM Revenue & Customs (HMRC) regulations they would have to apply an emergency tax rate on the rest.

His pension provider went on to explain that whilst an emergency tax rate would be applied initially, this would not be his final tax year-end position and by taking the £25,000 lump sum in addition to his regular income, his total yearly earnings could go into the higher rate tax bracket. John was advised to contact HMRC to check what his final year-end tax position would be.

John went ahead and cashed-in his £25,000 pension policy and after emergency rate tax was applied he received a cheque for £18,134, so had paid £6,866 in tax.

John contacted HMRC to find out what his year-end tax position would be. When they looked at all of his yearly income of £40,000 plus the £25,000 cash lump sum he had received from his pension policy, they confirmed that John had actually overall underpaid on his yearly tax by £34.

Please see below for a breakdown on John’s final tax year-end position.

John’s year-end tax position not including £25,000 pension fund withdrawal:

Other Income £40,000
Personal allowance £11,000
Tax due: £40,000 - £11,000 = £29,000 @ 20% = £5,800

John’s year-end tax position including £25,000 pension fund withdrawal:

£40,000 income earnings + £18,750 (£25,000 – 25% tax free amount) = £58,750

£58,750 – Personal allowance of £11,000 = £47,750

£32,000 to be taxed @ 20% = £6,400
£15,750 to be taxed @ 40% = £6,300

Total year-end tax due, £6,400 + 6,300 = £12,700

At year-end, John had paid £12,666 in tax (£5,800 from his £40,000 earnings + £6,866 from his initial tax payment from his pension fund).

He was actually due to pay £12,700 in tax due to his yearly earnings (£40,000 + pension fund lump sum). This meant he has underpaid by £34.

John also realised that by taking his entire pension savings as a cash lump sum, this had pushed his total yearly income into the higher rate tax bracket which had meant that £15,750 of his £25,000 pension fund had been taxed at 40%.

How will HMRC claim John’s underpaid tax?

HMRC will automatically assess the tax paid after the end of the tax year and contact him directly to correct any under payment.

This case study is a fictional representation of people’s experiences and is for illustration only. It is based on an individual pension policy. Everyone’s circumstances are different and your personal circumstances, however similar to the case study, need to be taken into account when reviewing your pension. This case study does not constitute tax advice or advice or guidance regarding your pension and you should seek pension guidance before making any decision.

Personal allowance and tax rates used are based upon rates for 2016/2017

Taking your full lump sum from your individual pension savings in stages could save you tax.

Linda was earning £30,000 a year working as a college lecturer. As she approached her 55th birthday, she was looking to carry on working but cash in her £25,000 pension policy and take it as a lump sum. When she contacted her pension provider to talk through the option of taking her entire pension savings as cash, one of the considerations was the risk of this taking her earnings into the higher rate tax bracket.

She wanted to make the money work for her as much as possible, so she went away to seek advice from a tax adviser.

She was informed that if she took out the whole £25,000 as a lump sum, the first 25% would be tax free but due to HMRC regulations her pension provider would have to apply emergency tax to the remaining amount. This would not however be her year-end tax position and to gain a final year-end tax position HMRC would add the cash received from her pension fund to any other income she received.

If Linda took the entire £25,000 out in one go and taking into account her £30,000 a year salary, her final year-end tax position would mean she would pay a total of £8,700 tax on her income for the year.

Please see below for a breakdown on Linda’s final tax year-end position if she took the entire £25,000 in one go.

Linda’s year-end tax position not including £25,000 pension fund withdrawal:

Other Income £30,000
Personal allowance £11,000
Tax due: £30,000 - £11,000 = £19,000 @ 20% = £3,800

Linda’s year-end tax position including £25,000 pension fund withdrawal:

£30,000 income earnings + £18,750 (£25,000 – 25% tax free amount) = £48,750

£48,750 – Personal allowance of £11,000 = £37,750

£32,000 to be taxed @ 20% = £6,400
£5,750 to be taxed @ 40% = £2,300

Total year-end tax due, £6,400 + 2,300 = £8,700

Linda then looked into what would happen to the amount of tax she would pay if she took her £25,000 pension pot over 2 years.

Linda’s year-end tax position including £10,000 pension fund withdrawal in year 1 and £15,000 in year 2:

Tax year 1:
£30,000 income earnings + £7,500 (£10,000 – 25% tax free amount) = £37,500

£37,500 – Personal allowance of £11,000 = £26,500

£26,500 to be taxed @ 20% = £5,300

Total year-end tax due year 1 = £5,300

Tax year 2 (assuming no increase in income and no changes to personal allowance amount):
£30,000 income earnings + £11,250 (£15,000 – 25% tax free amount) = £41,250

£41,250 – Personal allowance of £11,000 = £30,250

£30,250 to be taxed @ 20% = £6,050

Total year-end tax due year 2 = £6,050

Comparison of taking the whole of your pension fund in tax year 1 or splitting the amount over 2 tax years

Amount of tax paid in year 1: £30,000 regular income plus taking the entire lump sum of £25,000 = £8,700
Amount of tax paid in year 2: £30,000 regular income only = £3,800
Total amount of tax over a 2 year period = £12,500

Amount of tax paid in year 1: £30,000 regular income plus taking £10,000 from pension fund = £5,300
Amount of tax paid in year 2: £30,000 regular income plus taking £15,000 from pension fund = £6,050
Total amount of tax over a 2 year period = £11,350

Tax saving of £1,150

This case study is a fictional representation of people’s experiences and is for illustration only. It is based on an individual pension policy. Everyone’s circumstances are different and your personal circumstances, however similar to the case study, need to be taken into account when reviewing your pension. This case study does not constitute tax advice or advice or guidance regarding your pension and you should seek pension guidance before making any decision.

Personal allowance and tax rates used are based upon rates for 2016/2017