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Save Tax When Taking Your State Pension

Newsletter issue - March 08.

If you are like Bruce Forsyth and have deferred taking your state pension as you are happy working, you need to carefully consider the timing of when you do take up that pension. You have two choices when taking your deferred state pension:

  • Draw an enhanced weekly pension; or
  • Take a lump sum plus the normal weekly amount.

The enhanced weekly pension is taxable just like the normal pension. If you defer taking your pension until after 6 April 2008 you will have an increased tax free personal allowance of £9,030 (if aged under 75) to set against that income. However you need to estimate your total income for the tax year, as if it exceed £21,800 your age allowance will be reduced.

The lump sum pension payment is taxable at the top rate of tax you pay in the year you become entitled to receive your deferred pension, not necessarily the date when you actually receive the lump sum. So the date you claim your deferred pension could be crucial.

The lump sum is not added to your total income to work out your marginal rate. If the top tax rate you pay on other income is 20% (for 2008/09), then the full lump sum will be taxed at 20%. Similarly if your personal allowance fully covers all your other income so you pay no tax, the lump sum is taxed at a nil rate.

If you are planning to stop work and take your state pension, cease your earnings in 2007/08 then take your pension lump sum in 2008/09, and possibly defer your personal pension until 2009/10. In this way you will minimise the marginal tax rate in the year the lump sum falls into.