Pensioners can make ‘magic’ move to nearly half tax bill | Personal Finance | Finance

As uncertainty continues to loom large over Rachel Reeves‘ plans to raid pension pots, savers are scrambling to save as much money as they can while the old rules still apply. One major way pensioners could be paying more tax than necessary is through making large withdrawals all at once, experts at an investment firm have warned.

Data shared with The Times shows that hundreds of people paid over £98,000 in tax on their pension pots between October 2023 and March 2024, sometimes for retirement pots totalling around £250,000. While the majority of pensioners don’t withdraw their pots all at once, they could still be paying nearly twice as much tax on their pension as they need to by not prioritising efficiency in their withdrawal and wider saving habits. Most private sector workers have defined contribution schemes, giving them the choice of withdrawing a tax-free lump sum and leaving the rest invested for later income, or spending the remaining 75% on an annuity, which pays out a guaranteed lifelong income. However, a “magical” third option – of leaving the pension completely untouched – could be the key to savingthe most money on taxes.

By “crystallising” pension pots, savers could ensure that 25% of each withdrawal is tax free – when withdrawn alongside other income from their retirement funds.

The gradual “crystallisation” of a pot would mean not using your tax-free income and instead withdrawing, for example, £25,000, each year – 25% of which would be tax-free.

Because defined contribution pensions depend on how much you pay in, if a saver had no other income, they could also withdraw a further £12,570 tax-free because of personal allowances, according to investments platform AJ Bell.

That would mean only £6,180 of income being taxed, which, charged at the basic rate of 20%, would give you an income tax bill of £1,236.

Mike Ambery from Standard Life told The Times: “You don’t necessarily need to take all your tax-free lump sum in one go.

“You can usually take it in chunks of months or years. This can sometimes give you an income each month without paying any tax at all.”

Helen Morrissey from Hargreaves Lansdown suggested savers can also lower their tax bills by diversifying the sources of their income,

She said: “Look at your other assets. Income can be taken from your ISA tax-free, so you may choose to get your retirement income from a mix of your pension and ISA to keep that tax bill down.”