Beat the taxman

Hello again, one and all! You may remember from our videos and previous blogs that the Taxman helps when you save into the RMDCP. For most of you, every £5 that you add to your pot only reduces your take-home pay by £4. (This might be different if you are on a higher tax rate.)

When it is invested, your pot can grow without attracting any tax on investment growth. Later, when you take money out of your pot, you must check you’re not going to pay more tax than you need to.

Your choices at retirement

You have three broad choices when the time comes to taking benefits from the RMDCP:

• Take all or part of your pot as one or more lump sums. Each time, 25% will be paid tax-free and the rest will be taxed as income. Known as “U.F.P.L.S.”.
• Use your pot to buy a pension (also known as an annuity).
• Take a regular income from your pot – this means keeping the pot invested and taking a regular taxable income when it suits you. This is known as “Drawdown”.

Options 1 and 3 are where you need to be on the ball to beat the taxman; this blog helps you with this. The examples are based on option 1, which can be tricky because you’re taking both tax-free cash and taxable cash each time. With options 2 or 3, all the tax-free cash will be paid to you when you start taking an income. If you keep your money in your RMDCP pot, Scottish Widows will offer you 1 and 2, but option 3 has to be done elsewhere.

Beating the taxman when taking your pot as one or more lump sums

Most people will start to receive a State Pension between age 66 and 68, so I’m going to cover two possibilities:

• That you retire before State Pension age and use money from your pot in RMDCP (and perhaps others) to bridge the gap between leaving employment and your State Pension starting.
• That you stay at work until you reach State Pension age and then receive income from the State Pension and start taking money from your pots in the RMDCP and perhaps others.

Retiring before State Pension age

You’ll initially have no State Pension income.

Based on the current annual Personal Allowance of £12,500, if you have NO other income, you’ll be able to take up to £16,666 a year from your pension pots without having to pay income tax.

This is because 25% of what you take from your pot at any time (that’s one quarter) is tax-free cash and the other 75% (that’s three quarters) is treated as income. So, if you take £16,666, £4,166 of that is tax-free cash, and £12,500 is taxed as income. Your Personal Allowance is £12,500 and so no tax is payable.

Retiring at State Pension age

Based on the current annual Personal Allowance of £12,500, if you’re entitled to the full State Pension of £9,110 a year, and have no other income, you can take up to £4,520 a year from your pension pots without having to pay income tax.

The logic is as above - 25% of what you take from the pension pot is tax-free cash, and the other 75% of what you take is treated as income. Of the £4,520 taken out, £1,130 is tax-free cash, and £3,390 is taxed as income. Together, the State Pension of £9,110 and your pension income of £3,390 is the same as your Personal Allowance of £12,500 and so no tax is payable.

A word of warning

Any pension taken over that amount of £12,500 is then treated like earned income and is liable for income tax.

Scottish Widows might apply an emergency tax code; that code is likely to overstate the tax due as it assumes you would receive that amount each month.

In the example above, it would think you receive £4,250 each month, or £51,000 each year. With 25% tax free, it would think you receive (£38,250 pension + £9,110 state pension) £47,360 each year and do a tax calculation on that.

It is important to alert the administrator to your true tax position, and to apply to HMRC for a tax refund if too much tax has been taken.

Conclusion

In addition to saving income tax when you contribute to RMDCP and benefitting from a generous contribution from Royal Mail on top – you can invest and grow your pot without paying capital gains tax too. And you should be careful when taking your money you don’t pay more tax than you need to, by being clever with your withdrawals or doing a tax return.

Wishing you all the very best, Ben