LV= warns of tax overpayment on pension withdrawals

Pension withdrawals have been rising as a result of the coronavirus pandemic, according to LV=, after research from the retirement expert found that 155,000 people have been pushed into early retirement.

LV= was responding to new HMRC figures that showed the amount of money claimed back by people who drew money from their pensions and overpaid tax reached £25.7m in the fourth quarter of 2020.

Taking a big lump sum from a pension can lead to a large tax deduction, and LV= said that one-off withdrawals can be heavily taxed because pension schemes must normally start deducting tax using the emergency code. The retirement expert highlighted that this means the tax system treats the withdrawal as a new monthly income, and tax will be deducted as if the payment is a twelfth of the annual income.

This can often result in a large overpayment of tax which won’t be repaid until the end of the tax year, LV= warned.

LV= director of savings at retirement, David Stevens, commented: “On retirement, many people’s first instinct is to request their full tax free cash entitlement. However, unless a large lump sum is needed for a specific purpose, this is not always the wisest course of action.”

The retirement expert explained that it is still possible for a couple to have a combined income of £33,333 without paying tax, because there would no income tax payable.

Since all the drawdown income would fall within their tax free personal allowances of £12,500 for 2020/21, this means less pension savings would be needed to provide the required income.

LV= highlighted that the minimum amount necessary to produce the income is drawn from the pension, allowing the remaining tax free cash entitlements to remain outside of each person’s estate for inheritance tax purposes. The remaining pension funds could continue to grow within the tax advantaged pension wrapper, including their remaining tax free cash entitlements.

Stevens added: “If flexibly accessing a pension, it can often make sense to retain most of the tax free cash entitlement until a later date, looking to utilise the personal allowance – and potentially the basic rate tax band – to draw tax efficient income instead.”

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