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Forum Home  →  Discussion  →  Income support, JSA and tax credits  →  Thread

Pension Pot - Capital or Income.

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Advisor_1
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I have a client who, in 2015/16 came out of work and instead of claiming JSA or ESA, she cashed in a Pension Pot worth £25K. She has nothing left in the pot and cashed in the whole entitlement. She has used this to live on since approx. August 2015 She did not claim HB etc, but was claiming WTC and didn’t declare it.

When she has completed her Annual declaration, she called HMRC who advised that the Pension would be classed as ‘other income’ and needed to be declared. She has obviously then told them and an overpayment of £3500.00 has arisen.

Should the pension pot be classed as income, or should it be capital. CPAG states that all Pension Income is taken in to account, but this was a one off payment and im not sure if it should have been counted as capital instead.

Any thoughts.?

Paul_Treloar_AgeUK
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Hmm, could be tricky I think. Reg.5 of Tax Credits (Definition and Calculation of Income) Regulations deals explicitly with working out income, if any, from pensions. In Table 2 of this reg, we see a list of pension income to be disregarded and this includes at number 10:

A lump sum on which no liability to income tax arises by virtue of section 636A of the Income Tax (Earnings and Pensions) Act 2003

In which case, the lumo sum is disregarded. Whilst I can’t be certain what sec.636A of that Act is actually about currently as it remains unconsolidated and there’s been masses of amendments, it is also clear that a £25,000 lump sum would (or should) have attracted an income tax liability as it’s over the lower tax threshold however you slice it.

I can;t see there are any of the other disregards listed that could apply alternatively.

Then reg.5(1)(o) stipulates that pension income includes any lump sum to which sec.636A or 636C of ITEPA applies - again, I can’t be sure what these relate to so I am not entirely clear if these references do refer to pension freedom drawdowns like those of your client but it looks likely from scanning some of the amendments.

Sorry I can’t be more clear, maybe someone like Victoria from LITRG might be able to clarify perhaps?

Paul_Treloar_AgeUK
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Should also add that reg.5(3) also states that any income tax liability should be deducted from the treatment of that lump sum.

Advisor_1
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Great, thanks Paul. Much appreciated.

Victor
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Surely if she came out of work she would not be entitled to any WTC, whatever other income she had?

Paul_Treloar_AgeUK
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Victor - 10 August 2016 03:01 PM

Surely if she came out of work she would not be entitled to any WTC, whatever other income she had?

It’s an annualised award don’t forget, so she could, for eg, receive 6-months of WTC with earnings taken into account, but the WTC award is assessed with relevant income over the 12-month financial year, so that’s possibly where the problem has arisen?

ClairemHodgson
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i recently looked at taking some of my pension pot, and it transpires that you do have to pay some income tax on it if you draw a lump sum (whole or part), the tax being taken off at source before you get the money.  you also have to say whether you expect any income (so they can calculate the potential tax, i think)

Gareth Morgan
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This needs some more detail I’m afraid.  When was it exactly? We need to know whether it falls under the new rules/freedoms.  Did she take it as one lump sum or several?  What tax was applied to it by the provider?  Did she give the provider a tax code? 

I would expect that 25% was tax free which may make it disregarded in full (I’m away without my tax library atm).  The rest may have had emergency tax applied to it - or not. If she took the lot in several chunks then it may have been as drawdown or as UFPLS which have different tax treatments.

Paul_Treloar_AgeUK
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Gareth Morgan - 10 August 2016 05:44 PM

This needs some more detail I’m afraid.  When was it exactly? We need to know whether it falls under the new rules/freedoms.  Did she take it as one lump sum or several?  What tax was applied to it by the provider?  Did she give the provider a tax code? 

I would expect that 25% was tax free which may make it disregarded in full (I’m away without my tax library atm).  The rest may have had emergency tax applied to it - or not. If she took the lot in several chunks then it may have been as drawdown or as UFPLS which have different tax treatments.

When was it exactly? - 2015-16
We need to know whether it falls under the new rules/freedoms. - Yes therefore
Did she take it as one lump sum or several? - from o/p “she cashed in a Pension Pot worth £25K” which sound like whole pot in one go but see below anyway
What tax was applied to it by the provider? - £25,000 would be 20% iincome tax at the least
Did she give the provider a tax code?  - if she didn’t, she’s very likely got income tax repayment to contemplate as well but as Claire says, these are usually taxed at source, sometimes at emergency tax rate

As to the other questions, I’m struggling to see what real difference it’s going to make as to whether it’s income or capital - to me, reading the regs, unless it’s a lump sum that doesn’t attract any income tax at all, then it’s going to be taken into account either way unfortunately.

I’ve also just had the brainwave of checking CPAG 2016/17 p.1423 and that confirms what I’d posted previously i.e. tax-free lump sums ignored, tax-free amounts ignored, otherwise, pension payments as income or capital taken fully into account as income.

Advisor_1
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Apologies for the delay in replying. Ive been waiting for the client to provide full details.

So the total of the Pension Pot was £31857.84, on 30/10/2015 she took a 25% tax free lump sum, leaving £16891.86. Tax was then deducted of £6048.40 and on 04/11/2015 she received the remaining £10843.46.

Does this make any difference to what has already been posted?

thanks

ClairemHodgson
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Advisor_1 - 16 August 2016 11:50 AM

Apologies for the delay in replying. Ive been waiting for the client to provide full details.

So the total of the Pension Pot was £31857.84, on 30/10/2015 she took a 25% tax free lump sum, leaving £16891.86. Tax was then deducted of £6048.40 and on 04/11/2015 she received the remaining £10843.46.

Does this make any difference to what has already been posted?

thanks

not sure the figures add up

25% of 31857.84 is 7964.46 which would leave 23893.38, not 16981.86.

is she saying that the tax was deducted from what was left in the pot?  that doesn’t strike me as correct, my understanding is that tax is deducted from the amount taken from the pot? (see the pensions advice stuff).

Gareth Morgan
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25% tax free of £31,857.84 is £7,964.46 leaving £23,893.38.  20% tax on that would be £4,778.68.  As she paid £6,048.40 it would seem, if that is the correct total tax figure, that she paid some higher rate tax.  A quick calculation shows that that means she would have had to have had taxable income of about £35,000 in that tax year. 

Emergency tax on £16,891.86 would be £4,167.56 while on £23,893.38 it would be £6,492.51.  That would be adjusted at the end of the tax year to a real rate, or on her application if she made it earlier.

I suspect that her figures need checking to make sure that the correct figures are being used in any assessment.

As far as any WTC overpayment is concerned, there are different issues surely.  The crucial one is whether her hours entitled her to WTC during this period.  If they didn’t then it should be an overpayment decision that takes no account of this pension.

Gareth Morgan
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ClairemHodgson - 16 August 2016 12:52 PM

is she saying that the tax was deducted from what was left in the pot?  that doesn’t strike me as correct, my understanding is that tax is deducted from the amount taken from the pot? (see the pensions advice stuff).

It depends upon when the pot is ‘crystallised’.  If its an ‘uncrystallised funds pension lump sum’ (UFPLS) then each withdrawal (ignoring some complexities for over 75s) will have 25% tax free and tax at the marginal rate applied to the rest.  This could be the whole amount in one go or many smaller withdrawals.  Spread over several tax years this can avoid high rate tax being applied in many cases or even standard rate tax for many people.

The alternative, in the main, is Flexi-Access Drawdown where you can take up to 25%  of your pension pot as a tax-free lump sum. You then move the rest into one or more funds that allow you to take a taxable income at times to suit you. Most people will use it to take a regular income.

Once you’ve taken the tax-free lump sum you can start taking the income right away or wait until later..

You can also move your pension pot gradually into income drawdown. You can take up to a quarter of each amount you move from your pot tax-free and place the rest into income drawdown.

In this case it seems to have been a case of emptying the pot,  The first tax free bit was paid immediately and the provider then worked out tax and paid the rest a little later.

Advisor_1
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This is the document she brought me this morning. It suggests that the remaining sum was moved in to a drawdown pot but then she has chosen to withdraw it all immediately.

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Gareth Morgan
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Puzzling.  She seems to have had almost exactly £7,000 more tax free than she should on those figures.  If she had had only about £4,000 of taxable income in that year then they might have added the remainder of her tax allowance into the calculation but that seems unlikely.  It’s also vaguely possible that she has another £28,000 in a separate pot with them and they’ve taken the tax free lump sum from that as well.

Are you sure that she’s given you all the information?  Was she due a rebate or something else that gave her a lower tax code?

Advisor_1
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HI, She only worked for part of the year that year (approx. April-September, so there is a possibility tat she has received more than the standard tax free allowance because she had additional allowance to use. She has no other pensions or savings anywhere and cashed in everything that she had.

I was a bit puzzled by the amounts as well as I couldn’t get them to stack up.

But I think essentially the overpayment stands based on what im reading.