If l cash in my small pension once I am no longer working, will I have to pay 20% tax on it? I won’t have any other income at the time. My pension is only worth about £5,000. I understand that I will get 25% tax-free, but as l won’t be working will l receive it all tax-free as it is under the personal allowance?
Small pension pots like yours can be withdrawn very tax efficiently. However, you need to take account of all the taxable income you receive in the same tax year. You need to make sure there is enough of your personal allowance (£11,850 in 2018/19, rising to £12,500 in 2019/20) remaining to allow for the proportion of the pension that HMRC considers as ‘taxable income’.
In most cases, that will be 75% of the pension value but it does depend on what type of pension scheme it is. For instance, with an old occupational scheme or Section 32 buyout, the tax-free cash element could be lower or higher than 25% of the fund value.
If you find you don’t have enough allowance left in this tax year but you won’t be working in the tax year that begins on 6 April 2019, consider delaying withdrawing the money until then.
Due to HMRC rules, you should expect your pension provider to deduct tax at source in the first instance, irrespective of your tax position at the time you cash in your pension. If you are eligible to claim back any overpaid tax, you can do so by completing HMRC’s P50Z form, available at Gov.uk.
Finally, just because you can do something, it doesn’t mean you should. Withdrawing money from your pension fund might affect your eligibility to claim state benefits, either now or in the future. I would recommend that you seek independent financial advice (or guidance from Pension Wise) before you withdraw any money out of your pension to ensure that you make an informed decision.