Tax transition when first retiring

[MrFoolish]

How does the tax transition work when taking early retirement?

Say you were putting into a SIPP and claiming tax relief, something you had been doing for many years. Then you retire and start drawing an income from that SIPP. Is it all ok that one month you were claiming tax relief and the next month you are taking money out? I can't see why it wouldn't be the case, but thought I'd ask.

I suppose your drawdown adds to your gross wages so far that tax year, so perhaps you should initially tap into an ISA? Or do that 25% tax free thing?

Hope this makes sense.

Thanks.

[tjh290633]

The way the tax system works is that a sudden reduction in your income generates a tax refund each month, based on the total so far and the tax paid previously. Eventually your tax code will change. You might end up on a month 1 basis for a time. In that case it will only be on the amount that you get by drawdown that month, but moving to a lower tax band overall will eventually lead to a refund.

What happens when depends upon what your employer tells the tax office and what you do. Presumably your SIPP manager will get a tax code for you and deduct the correct amount. Others in drawdown can answer that. If you have an occupational or other pension as well, one will get the principal tax code and the others may be told to deduct the basic rate or a higher rate.

Simple it is not.

TJH

[MrFoolish]

Oh, and to add a related question... what is a good strategy in the run-up to this early retirement, should you maximise contributions to the SIPP? And if you are mostly in equities, without much of a reserve fund, could you add to the SIPP but just leave it sitting there in cash?

[tjh290633]

I think that, if you would otherwise be a higher rate taxpayer, you should use your SIPP subscription to keep below the relevant threshold. If you have more funds available and would be a standard rate taxpayer, then put money into an ISA.

How you organise your cash reserve is up to you. My inclination would be to do it outside a tax shelter, because the low rates of interest do not help. A cash ISA may be a convenient place to hold your cash, but cash does not need to be in a tax shelter at this time. Were interest rates at a sensible level, then the answer is different. I consider that rates should never have fallen below 2.5%.

TJH

[Urbandreamer]

I am approaching this point and have a number of things to consider.

Will I or won't I be paying income tax. I may have a choice. I need to write to a pension provider and ask if there are penalties to claiming a DB pension early, or not.

If I am not to pay income tax, then I need to contact a number of charities. To let them know that, while I wish to continue to contribute, they can't claim gift aid upon those contributions.

I am contributing as much as I can afford into my SIPP as clearly the tax uplift will provide "free" money as part of the tax free amount and further "free" money if I draw less than the personal allowance.

Everyone has differing risk tolerance. I'm still buying equities even though I intend to retire next year. That said I do have 6 months worth of spending in cash and the dividend income almost matches my spending.

What I have done is try to split my portfolio on a spreadsheet into short term (lower risk) assets, medium and adventurous. I intend to manage the balance where previously I did not. I'm somewhat hampered by my liking of Tech stocks and emerging markets.

[Lootman]

The way the tax system works is that a sudden reduction in your income generates a tax refund each month, based on the total so far and the tax paid previously. Eventually your tax code will change.

Or you may cease to have a tax code at all.

Since I stopped working 20 years ago, my sole income has been from rents, dividends, interest and capital gains. I have not been under PAYE, and there is no need for a tax code since there is no tax withheld from my income. All I have to do is submit a self-assessment tax return each year, along with a cheque for the amount of tax due.

I have deferred the receipt of three pensions I am entitled to, and presumably when I start collecting then I will need a tax code and I will come back into PAYE. But until then I can ignore all that. So for those who retire but defer pensions, no tax code is needed.

[MrFoolish]

Thanks for all the responses.

What happens if you retire very early in a tax year? You might get some tax relief in your SIPP you weren't entitled to. Do they grab it back via some year end adjustment?

[Dod101]

Thanks for all the responses.

What happens if you retire very early in a tax year? You might get some tax relief in your SIPP you weren't entitled to. Do they grab it back via some year end adjustment?

That should all come out in the wash when you do a self assessment return. Most of your concerns will sort themselves out that way.

I am similar to Lootman's position. I have no tax code and if I decide in March this year to draw some money from my SIPP, 40% or whatever the top rate of tax is in Scotland will be deducted before I receive it. I will then complete a self assessment tax return to 5 April 2022 and reclaim almost all of it because I pay very little tax. Nearly all my income is in the form of dividends which are mostly derived from shares held in ISAs.

Dod

[MrFoolish]

I am similar to Lootman's position. I have no tax code and if I decide in March this year to draw some money from my SIPP, 40% or whatever the top rate of tax is in Scotland will be deducted before I receive it. I will then complete a self assessment tax return to 5 April 2022 and reclaim almost all of it because I pay very little tax. Nearly all my income is in the form of dividends which are mostly derived from shares held in ISAs.

Dod

So if you take a big chunk in one month, they multiply it by 12 and take way too much tax, requiring you to reclaim it?

[Dod101]

I am similar to Lootman's position. I have no tax code and if I decide in March this year to draw some money from my SIPP, 40% or whatever the top rate of tax is in Scotland will be deducted before I receive it. I will then complete a self assessment tax return to 5 April 2022 and reclaim almost all of it because I pay very little tax. Nearly all my income is in the form of dividends which are mostly derived from shares held in ISAs.

Dod

So if you take a big chunk in one month, they multiply it by 12 and take way too much tax, requiring you to reclaim it?

Not exactly. I just take a lump sum as and when. I do not drawdown every month. If the SIPP manager does not have a tax code for me they just deduct the top rate of tax. I have not drawn anything for two or three years (One of the benefits of a SIPP is that you do not have to draw a regular or any amount in any one year) I then claim the adjustment of the overpaid tax in my self assessment. To expand slightly on that, I adjust how much, if any, drawdown I take, to ensure that I get most of the tax deducted by the SIPP manager returned to me. I achieve that by leaving my request for a payment until late in the tax year when I know if say I have a CGT bill or whatever.

Dod