27 June
By Chris Gumbley
Categories: Personal/Government/HMRC/Taxation

Can I save tax on my state pension lump sum?

Can I save tax on my state pension lump sum?

If you reached state pension age before 6 April 2016 you might be able to take advantage of a tax saving opportunity in connection with your state pension lump sum.  The opportunity exists if you meet one of two conditions. 

These are:

  • You have not yet started to draw your state pension or
  • You have started to draw your state pension but are now willing to suspend it for a period of at least a year.

Individuals who start to draw, or resume drawing, their state pension have the option of accepting an enhanced pension or a basic pension and a lump sum.

Those who decide to take the basic pension and a lump sum will find that the lump sum is taxed in a quite unique way.  The amount of tax an individual has to pay on the state pension lump sum depends on his or her marginal tax rate in the tax year in which he or she takes the lump sum.

In 2018/19 we have the following rates of tax
Income up to         Rate
£11,850                 0%
£46,350                20%
£150,000              40%
Over £150,000     45%

An individual who has income up to £11,850 pays no tax whatsoever on the state pension lump sum.  An individual who has income of between £11,851 and £46,350 pays tax at the rate of 20% on the lump sum.  Unlike all other income sources, the state pension lump sum is not aggregated with an individual’s other income when computing the amount of tax payable.

This unique method of calculation opens up a tax planning opportunity.  If you have control over the level of your income, for example by virtue of having significant control over a family company or partnership, you may be able to reduce your income in the tax year in which you take your state pension lump sum.  This will reduce the rate of tax you pay on the lump sum.

An individual entitled to a lump sum of £40,000 who is usually a 40% taxpayer might manage his or her other income so that it does not exceed £46,350.  The tax saving on the lump sum is £8,000.

Think you might be eligible?

Our strategic tax planning services gives you the confidence that your finances are optimised to suit your lifestyle and meet your future plans.

If you reached state pension age before 6 April 2016 and think you might be eligible to take advantage of this tax saving opportunity, please get in touch. Our dedicated tax team will be happy to talk through your particular situation and ensure you are taking advantage of every tax saving opportunity available to you.