Will cashing in a pension affect my income tax?

[HarryChadwick]

Hi there.

I live on a low income, so pay very little tax. My gross annual income from all sources (employment, plus a small civil service pension income) is around £13,500 - or just over £12,000 net. My tax code for the current year is 1250L.

I have a small pension pot which I have decided to cash in early. It's £12,250, and by taking it all at once I realise I'll be taxed on 75% of it - leaving me with around £10,000. I'm presuming it's taxed at source. My question is... once I've cashed it in, is it likely to affect my tax status? What I mean is... will HMRC regard my total gross income for the year as £25,750 and then base my stoppages on that figure, or will the tax on the pension be dealt with separately and therefore leave my other income as it is (i.e. tax based solely on the usual gross income of £13,500)?

I hope that makes sense. It probably sounds obvious... but I'm just concerned that my cashing in the pension, and therefore effectively having a higher annual income, will mean that I'll pay more tax.

[D&C]

I think you have got a little confused.

If you have a defined contribution pension pot of £12,250 and choose to take it all one go then 25% will be tax free and 75% will be taxable income.

HMRC are only interested in the taxable element, £9,187.

So it will be a fact that you have taxable income of £22,687 including your normal pension income.

This is unlikely to change anything with regard to your original pensions but you will ultimately have to pay £1,837 in tax on the small pension pot, leaving you with £7,350 (plus the tax free lump sum).

If you take it all in one go you may pay more than £1,837 in tax and HMRC will refund any excess tax deducted in due course. You pay more when the pension is paid out as you are taking the equivalent of an annual pension of £110k in one go so some 40% tax is deducted.

[D&C]

I suppose the short answer is yes, of course you will pay more tax. As you are already paying tax you cannot expect to take an extra £9kctaxsble pension and not pay any more tax