‘I would like to cash in my private pension – will I pay a lot in tax?’ Jasmine Birtles answers your questions

Jasmine replies: That’s a sensible question. Too many people take money out of their pension in a big lump that then forces them to pay extra in tax.

I spoke first to financial advisor David Braithwaite who runs Citrus Financial about this.

He said: “Assuming your pension is a personal pension and assuming you have not taken anything from it so far, most pensions allow 25 per cent of the value to be taken tax free, the balance is taxed at your marginal rate of tax – i.e. if you had earned it. So in this case, for the £87,000 pension, £21750 is tax-free, the remaining £65250 is taxable.

“If you took the whole amount, then this figure of £65,250 would be added to your £15,000 rental income, making your total earnings £80,250, so you would pay income tax on that earning.

“The first £12,570 is your personal allowance so zero per cent tax, you will pay 20 per cent tax on the next amount of to £50270, and 40 per cent tax on anything above that. It’s fairly tax punitive for you to “cash in” a pension in one go like this.

“Another way to do it is to stagger the withdrawals if your pension policy allows it, or you transfer to one that does, that way you can spread the withdrawals over tax years, especially to avoid pay the higher 40 per cent tax rate perhaps?”

There is a useful article on the government’s website, Moneyhelper, about taking lump sums from your pension here.

I also spoke to Megan Rimmer, chartered financial planner at Quilter Cheviot. She reiterated what David Braitwaite said above but added: “By taking smaller amounts over several tax years, you might avoid crossing into higher tax brackets.

“It is important to check whether your pension can facilitate this option (called flexible access drawdown).

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“Some pension schemes will not allow you to do this and you may need to transfer your pension to an alternative scheme.

“It’s also worth remembering that if you take a taxable income from a pension, you trigger the money purchase annual allowance meaning you can only pay £10,000 in your pension every year. This is another important consideration, particularly if still paying into a pension.

“Always keep in mind that pension rules and tax thresholds may change, so it’s wise to review your options with a financial adviser to tailor a strategy that aligns with your long-term financial goals.

“By planning carefully, you can maximise your pension without an excessive tax burden.”

Jasmine Birtles is a personal finance expert, TV and radio presenter and author of 38 books. Her website, MoneyMagpie.com, covers all aspects of personal finance from money-saving and money-making ideas to investment and pensions information. She is a keynote speaker at conferences around the world.