This depends on whether you give up part of your pension to receive a tax-free lump sum. If you don’t give up your pension for a tax-free lump sum (or extra tax-free lump sum), we can pay 25% to you tax-free, and the rest is taxed as income.
Here is a broad example for Kate. Kate’s pension is £350 a year, plus an automatic tax-free lump sum of £1,000. Here is how much her pension is worth:
- the transfer value of her pension is £7,000
- plus her lump sum of £1,000
- her pension is worth £8,000
We can pay £2,000 tax-free, and the rest is taxed as income. If you give up your pension for a tax-free lump sum (or extra tax-free lump sum), as we have already paid you the maximum amount we can pay tax-free, your whole small pension lump sum will be taxed as income.
Here is a broad example for Simon. Simon’s pension is £700 a year. The transfer value of his pension is £12,000. He cannot take this as a ‘small pension lump sum’. He gives up £150 a year to receive a one-off, tax-free lump sum of £3,000. His pension is now £550 a year. Simon’s new pension of £550 a year is worth £9,000. After giving up part of his pension for a tax-free lump sum, Simon’s new reduced pension is worth less than £10,000 and he can take this as a ‘small pension lump sum’. He will pay income tax on all of it.
As we do not know your tax code, we use a basic rate tax code (BR) to work out your income tax. This may mean you pay too little or too much tax. In practice, if you are a basic rate taxpayer or you do not pay tax, you could end up paying too much tax. If you are a higher-rate taxpayer, you might not have paid enough tax, as it will only be taxed at the basic rate of 20%.
If you have paid too much tax, you can claim tax back. You can find out how to do this at gov.uk/claim-tax-refund/overview. If you have not paid enough tax, you can pay more through your self-assessment.
