How do I avoid paying tax on pension withdrawals?

Canny savers are making the biggest pension withdrawals in early spring to slash or erase tax bills, new research suggests.

Average sums taken out spike in March and April, as pension investors juggle their finances just before the end of the tax year.

Some retirees wait until the final months to do their sums to stay under income tax thresholds and avoid unnecessary payments to the taxman, explains Hargreaves Lansdown which carried out the research.

Thresholds for 2018/2019 tax year. You don’t get a personal allowance on taxable income over £123,700. Source: Gov.uk

Note that the top of the basic rate band is £43,430 in Scotland. You can find more on Scottish bands here.

The income tax bands for 2019/2020 are nil for up to £12,500 per year, 20 per cent for up to £50,000, 40 per cent for up to £150,000, and 45 per cent above that. Read more here, and for Scotland check here.

How do you manage pension withdrawals?

Nathan Long of Hargreaves Lansdown offers the following tips:

1. Balance income and tax: Pension income is taxable, so you need to make sure what other income you’ll receive in the year to work out what tax you’ll have to pay.

You can manage your income in line with particular tax bands, you start paying tax at £11,851 of income and higher rate tax at £46,350 (£43,430 in Scotland).

2. Plan together: It pays to plan your finances with your other half. Balance pension withdrawals with earnings from employment depending on your combined situation.

3. Use Isas for income: Anything withdrawn from an Isa is tax free, so it’s useful to squirrel spare money away into an Isa to act as a supplement to your pension income. 

You get to put away £20,000 into Isas each tax year, so there is plenty of scope up a tax free pot alongside.

4. Hold a cash buffer for pension income payments: Drawdown is riskier than buying a guaranteed income from an annuity because if your investments don’t perform as well as you expect you could run out of money.

Lessen the risk by holding a year’s worth of income as cash so as to avoid being forced to sell your investments if the market falls heavily.

5. Sell investments carefully: Be careful if you are selling investments to fund your income. It’s not necessarily best to sell from all of your investments equally.

Make sure when selling investments you don’t dramatically change the level of risk you are taking.