Pension freedoms - what you need to know before drawing income

Whilst we welcome the pension freedoms that were introduced in 2015, which granted greater access to pension benefits, they do bring with them complications that you need to understand before taking any income from pension savings. 

First drawing income 

When an income payment is first made from a pension scheme under PAYE rules, the pension provider must apply a temporary income tax code, known as “an emergency rate” until such time as they receive a tax coding for the individual or the individual can provide a P45 for the current tax year, if applicable. 

In most instances, this will result in an overpayment of tax, which, for an income payment taken perhaps annually in advance on ^1st May, could be substantial. This is because the PAYE system will assume that this “one off” payment will continue on a monthly basis and will apply only one month’s entitlement to the annual personal tax allowance. 

Where the income continues over the course of the tax year, provided the pension provider receives a tax code for the member, it is likely that the issue should resolve itself by the tax year-end, resulting in less tax deducted on subsequent payments. 

The member can either make application for immediate repayment of the overpaid tax or alternatively can wait until the end of the tax year and make application for repayment as part of their annual self assessment tax return process.

If you would like to find out more about this topic please contact your Financial Adviser or alternatively your Pension Consultant.