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Retirement: Surprising Impact of Tax-Free Pension Withdrawals on Benefit Payments

Retirement: Surprising Impact of Tax-Free Pension Withdrawals on Benefit Payments

Withdrawing a tax-free pension lump sum can have implications for your eligibility for certain benefits, such as tax credits and universal credit.

How does a pension lump sum work? Most pension schemes require you to be at least 55 years old to take a lump sum from your pension, known as the normal minimum pension age (NMPA). This age will rise to 57 in April 2028. Typically, you can withdraw up to 25% of the amount built up in your pension without paying tax. Previously, this was limited to 25% of your available lifetime allowance, but now the tax-free limit is set at 25% of the most recent maximum of £1,073,100. This means that the highest amount someone can withdraw from a pension tax-free will remain at £268,275 until further notice. Any lump sum taken above this amount will be subject to income tax.

Will my lump sum affect my tax credits? Tax credits are government payments that can fall into two categories: child tax credit and working tax credit. Working tax credit is designed to help those with low incomes stay in work, while child tax credit is for people with children, regardless of their employment status. In some cases, families can receive both credits simultaneously. Tax credits are being phased out in favor of universal credit, and no new claims are being accepted. If you are currently receiving tax credits and access your pension lump sum, it can affect your eligibility. However, it depends on what you do with the money. If you stick to the tax-free element of your pension, it won’t count as income for tax credit purposes. But if you take any additional taxable lump sum or income from your pension, it will be considered part of your income for tax credit assessment. While there is no savings limit for tax credits, you need to be cautious about where you put your new savings. If they generate more than £300, such as through investments, this can be deducted from your tax credit income.

Can taking a lump sum affect other benefits? Withdrawing a lump sum from your pension can also impact other means-tested benefits. For example, to be eligible for universal credit, you or your partner can only have up to £16,000 in savings. Anything over this threshold counts towards your income and can affect how much you receive. Similarly, pension credit has a savings threshold of £10,000, and anything above that amount is considered part of your income and affects your payment.

In conclusion, while accessing a tax-free pension lump sum can be beneficial for your finances, it’s important to be aware of the potential impact on your eligibility for certain benefits. It’s advisable to consider the tax implications and consult with a financial advisor to make informed decisions.

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