I retired officially a couple of years ago. At the time I had a big increase in my income, so I increased the amount put into long-term investments, and I spend the dividends generated by them. I also have several savings accounts.

I started a SIPP recently. My current intention is not to touch it before I’m 75. In the meantime, if I need more money, I could reduce the subscription payments and if necessary, sell investments in my ISA and dealing accounts. 

I am confused with all the percentages quoted when talking about pensions. I understand that I can take 25% tax free, but the rest is taxed as income. I presume that relates to an initial payment when starting drawdown. However, I don’t expect I will be taking a lump sum, but I will be taking a 1% monthly income. How much of that would be subject to tax?

I think it is unlikely that I will be subjected to anything other than basic rate tax during my lifetime.

Paul

Rachel Vahey, AJ Bell Head of Public Policy, says:

For those who don’t deal with pensions tax every day the rules can be quite complicated, and they are always worth a re-cap. 

Pension savers have a few options about how to access their pension pots. This flexibility means they can take income in a way that both suits their needs and can minimise the amount of tax they pay.

Pension savers can usually take up to 25% of their whole pension pot as a tax-free cash lump sum (as long as they haven’t gone over a limit of £268,275 which applies across all their pension pots). They could use the rest to buy an annuity – which pays a guaranteed income throughout their life – or keep the rest invested in drawdown and take an income from it when they need and want to. This could be a regular income or one-off withdrawals.

Any income you take from the pension pot is added to other income – for example from earnings or state pension – and will be subject to income tax.

The 25% tax-free amount is obviously a big tax perk. But if you don’t need the money then it may just sit in your bank account and could potentially be subject to inheritance tax when you die if you haven’t used it.

A RANGE OF OPTIONS

However, you don’t need to take all the 25% at the one time. There are other options. You can take just a small amount from your pension, instead of accessing all of it. Again 25% of this smaller amount will be tax free. The other 75% will be taxed and you can:

• move it into drawdown (this is sometimes called ‘drip-feed’ drawdown when you move small amounts over to drawdown on a regular basis) and then take an income from it whenever you want;
• or buy a small annuity with it.

You can also take single payments called ad-hoc lump sums or uncrystallised funds pension lump sum (UFPLS)), each of these payments are 25% tax free, 75% taxed.

There could be tax advantages to just cashing in small amounts of your pension when you need them. It means each income payment will be partly tax-free which can help keep your tax bill down.

It also means you are only taking what you need from your pension pot and leaving the rest of it invested tax efficiently – no income tax or capital gains tax is due on any investment returns – and by doing this you could boost your overall pension pot, including the tax-free amount.

Any untouched pension pot when you die will usually be sheltered from inheritance tax and can be passed on to loved ones. This could be more tax efficient than taking a regular income, investing it elsewhere if you don’t need it immediately, but which may fall into your estate when working out if any inheritance tax is due.

WORD OF WARNING

But just one word of warning. If you don’t use up your full 25% tax-free cash entitlement and you die after your 75th birthday, that tax-free entitlement cannot be passed onto your beneficiaries. The payments they take from inherited pensions may be completely tax-free if you die before age 75 but are taxed if you die after age 75.

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