Taxation on Lump Sum Pension Income Withdrawals

11th August 2021

Taxation on Lump Sum Pension Income Withdrawals

Taking a lump sum from your Flexi-Access Drawdown pension can result in some unexpected payments of tax and more income tax can be deducted than you may think. 

The taxing of a lump sum from your drawdown pension plan can be confusing and very tricky to predict. The information below is based on our understanding of HMRC’s guidance regarding how a lump sum payment could be taxed. 

Income from a pension is taxed under PAYE as earned income. Depending on whether the pension provider has had a P45 for the current tax year from a previous pension provider, or if they already have the tax code on file, then they will apply this. If they have not, HMRC require the provider to use a temporary rate to tax your income until they have issued a correct tax code. This tax code works on what is known as a ‘1 month’ basis. 

The ‘1 month’ basis means that the calculation used will have only allocated 1/12th of your tax-free personal allowance to your lump sum. The providers are required by HMRC to use this calculation even if the lump sum is the only payment made in that tax year. If the provider holds your current tax code, and your plan is Flexi-Access Drawdown the ‘1 month’ basis will still be applied. 

If you have overpaid tax, the pension providers are not able to refund this. HMRC may decide to inform them to amend the tax on future income payments to rectify your tax position. Alternatively, they could review your tax paid at the end of the tax year and issue a tax calculation to adjust your position. In some situations, you may be able to make a claim to recover any overpaid tax. 

We can only input the gross figures for your payments so it is worth checking the potential tax that may be due and anticipating that more tax may be deducted initially. 

You can check the tax that is due on a withdrawal via the HMRC calculator at:

PAYE Caculator

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