Tax rules change over time, different bands apply according to how much income you have, and different financial products are taxed in different ways. So it's hardly surprising if you're unsure how taxation might affect your retirement planning.
Here's some guidance on how you'll be taxed when you withdraw money, based on our understanding of 2014/15 tax year rules. Please bear in mind that these may change.
A pension is a long-term investment product, to provide for your life in retirement. Although it's not designed for short-term access, it is possible to take all the money in your pension as a lump sum – provided you're aged 55 or more.
You'd need to think carefully before deciding to do this. Here's how the tax works out:
- The first 25% of your fund will be tax free
- The remainder (if you take it as a lump sum) will currently be taxed at 55%. Your pension provider will deduct this tax.
From April 2015 the rules will change. The first 25% of any cash withdrawal will still be tax free, but the remainder will be taxed at your marginal rate.
To find out more about the changes, see How do I take money from my pension fund?.
Under the current rules, at least 75% of your pension fund must be used to buy a retirement income (at age 55 or later). This could be via a pension annuity or income drawdown.
A pension annuity provides a guaranteed income for life. It could also continue to provide an income to your dependants for a set period after your death, depending on the options you choose.
Any income you take via a pension annuity will be taxed at your marginal rate of income tax. Your annuity provider will deduct this tax.
From April 2015, you'll no longer have to use 75% of your pension fund to buy a pension annuity. Instead, you'll be able to use as much or as little as you like for this purpose – or not buy an annuity at all.
Any income you receive from a pension annuity will still be taxed at your marginal rate, as it is at present.
Income drawdown is a way of taking an income from your pension fund. You can use the money you take from income drawdown to retire fully, or you might use it to ‘semi-retire' and supplement your earned income. The amount you can withdraw is regulated – read more about income drawdown here.
While you're making withdrawals from your pension fund in this way, the remainder of your fund continues to be invested. This means it will still have the potential to rise or fall in value. Any growth will be free of UK income and capital gains tax – although some investment returns may be received by the pension fund after tax deductions, or with tax credits that cannot be reclaimed e.g. 10% tax credit on UK dividends.
From April 2015, you'll have greater flexibility around accessing your pension fund through income drawdown. You'll be able to take as much or as little income as you like in this way.
Any income you receive from income drawdown will still be taxed at your marginal rate, as it is at present. Your product provider will deduct this tax.
You can now save up to £15,000 every tax year in an ISA. There's no income tax or capital gains tax on any money you receive from an ISA. However you should be aware that some investment returns may be received by the ISA manager after tax deductions, or with tax credits that cannot be reclaimed e.g. 10% tax credit on UK dividends.
You can normally remove your money at any time. But you should bear in mind that, regardless of any money you withdraw, your annual limit remains fixed at £15,000
Here's how this works:
- Let's say you invest £15,000 at the beginning of the tax year.
- One month later, you withdraw all of it.
- You won't be entitled to save any more into an ISA in that tax year – you'll have used your full £15,000 allowance, even though you withdrew the money again.
A general investment account
This is simply an investment product where customers can invest directly into investment funds.
Any interest you receive on your investments will be taxed at your marginal rate and any dividends will be assessed for capital gains tax
When certain types of investment products pay you income, the provider sends you a tax voucher. The voucher will show two pieces of information:
- The amount of income you’ve earned.
- Where applicable, the amount of tax which has already been paid by the fund manager on your behalf.
The tax voucher provides you with the information you’ll need for your self-assessment tax return form, which you’ll need to complete and return to HMRC.
If you’ve received income from more than one fund of this kind – for example, dividend payments from three funds investing in shares – you’ll need to add up the total amount and insert the figure in the appropriate boxes on the tax return form.
Don’t forget, there’s an annual deadline for completing your self-assessment tax return form, and paying any tax due. If you miss these deadlines, you’ll have to pay a fine. To find out more about this, and tax issues in general, you can visit the HMRC website.