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When you are deciding how you want to use your pension account, it is important to consider the tax you would pay on the different options, and also the benefits you will receive from the State.

How does tax on retirement savings work?

When you are building up savings…

You won’t usually have to pay tax as you save into your pension account unless the amount you save into, or build up, over the tax year exceeds the Annual Allowance.

This means that saving into a pension arrangement is usually tax efficient, as you receive tax relief at your highest marginal rate of income tax.

For example, if you are a basic rate tax payer, for every £100 you save into your account, the amount you take home only reduces by £80.

 

When you retire

When you retire – that is – you access your pension account – the value of your pension account will be tested against the Lifetime Allowance.

If your pension account plus all other pensions savings you have taken are greater than the Lifetime Allowance then you will need to pay an additional tax charge; your pension account will be reduced to meet this charge.

In most cases, you can usually take up to 25% of your pension account within the Lifetime Allowance as a tax-free cash lump sum

Alternatively, if you are moving into a Drawdown arrangement or taking more than one cash lump sum, then you may be able to spread your tax-free cash by taking 25% of each future payment tax free.

When you’re drawing a retirement income

Once you have taken any tax-free cash at retirement, and paid any additional tax charges if you exceed the Lifetime Allowance, the rest of your retirement income will be taxed at the highest rate of income tax that applies to you when you receive it.

This works in a similar way to the tax you currently pay on your employment income, except you won’t have to pay any National Insurance Contributions.

If you are spreading your tax-free cash by taking 25% of each payment tax-free, then any amount above this on each payment will be taxed at the highest rate of income tax that applies to you when you receive the payment.

What are the Allowances?

The three main Allowances which apply to retirement savings are the Annual Allowance, the Lifetime Allowance and the Money Purchase Annual Allowance.

Annual Allowance

The Annual Allowance (AA) is the maximum value of retirement savings you can build up over a tax year without incurring a tax charge. The standard AA for 2020/21 is £40,000 but this can reduce to as low as £10,000 for individuals whose total income (including retirement savings) over the tax year is more than £240,000.

Lifetime Allowance

The Lifetime Allowance (LTA) is the maximum value of retirement savings you can build up over your lifetime (in all arrangements) without incurring an additional tax charge. For most people, the LTA for 2020/21 is £1.0731 million, and is due to increase in future years in line with the Consumer Prices Index. You may have a higher LTA if you applied for a form of LTA protection when the LTA reduced in previous years. It is your responsibility to let the administrators of your pension arrangements know if this applies to you.



Money Purchase Annual Allowance

The Money Purchase Annual Allowance (MPAA) normally applies once you have accessed your retirement savings and taken a taxable income. This includes taking taxable income from a Drawdown account, as well as the taxable part of a cash lump sum, known as an Uncrystallised Funds Pension Lump Sum or UFPLS. It doesn’t apply if you buy an annuity or if you take a small pot lump sum (see below).



What is a small pot lump sum and how is it taxed?

If your DHL Group Retirement Plan retirement savings are less than £10,000 you may be able to take this as a small pot lump sum. This means that you can take your entire DHL Group Retirement Plan retirement savings as cash. Up to 25% of the lump sum would be tax-free, with tax paid on the remainder. Taking a cash lump sum in this way would not trigger the Money Purchase Annual Allowance. The Pensions Department will let you know if you are eligible to take a ‘small pot’ lump sum rather than an Uncrystallised Funds Pension Lump Sum (UFPLS).

So how much tax will you actually pay on your retirement income?

You will pay tax on your retirement income at the rate of tax that applies to you at the time, which will depend on the amount of income you receive from all sources.

If you are currently employed and receiving a salary, taking your pension could potentially mean that you move up to a higher tax band.

In addition, if you decide to take all of your retirement savings as a cash lump sum in one go, even if you’re not still working, this could mean that you end up paying more tax, as you may move up to a higher tax band.

What tax will my dependants pay on my death?

The amount of tax your dependants pay depends on how you take your retirement savings and how old you are when you pass away. The current position is as follows.


Note that additional tax charges may apply if you die before age 75 and you do not have sufficient unused Lifetime Allowance (LTA) to cover any retirement savings you have not yet accessed.

State Pension benefits

State Pension Age (SPA)

When you reach your State Pension Age, you may also be entitled to receive a pension from the State called your State Pension.

The State Pension Age is currently between 65 and 68, and will depend on your gender and your date of birth. You can find out your State Pension Age (SPA) here.

State Pension

For individuals who reach State Pension Age on or after 6 April 2016, the full amount of State Pension is £8,767.20 a year (2019/20).

However, this amount will be lower if you haven’t paid full National Insurance contributions (or received full National Insurance credits) for 35 years.

This could be due to periods when you were not working and not claiming benefits, had low earnings, were ‘contracted-out’ of a pension plan, or were living abroad.

The amount payable to you will reduce proportionately depending on how many years’ full contributions you have made. You may be able to make voluntary National Contributions to fill any gaps in your contribution record.

You can find out the State Pension you will be entitled to receive here.

Tax on your State Pension

Income from your State Pension will be taxed at your marginal rate of income tax, in the same way as other retirement income.

How your State Pension increases in retirement

Currently, the new State Pension increases each year in line with whichever of the following is the highest:

  • the increase in average earnings
  • the increase in prices as measured by the Consumer Prices Index
  • or 2.5%.

Delaying your State Pension

You can find out more about delaying your State Pension on the Government’s State Pension website.

Other State benefits

You may also be entitled to other State benefits in retirement, like fuel allowance. Please visit the Money and Pension Service website to find out more.