Synopsis: When looking at the net proceeds from a UFPLS, it is dangerous to assume one marginal rate of tax applies throughout.

Date posted: Thursday, September 25, 2014

The opportunity to draw unlimited amounts from a pension fund as a lump sum has got the creative juices flowing in some marketing departments. Take, for example, something that crossed our path recently. To paraphrase (and disguise!):

‘Henry is a higher rate taxpayer. He draws £100,000 out of his pension and receives a £25,000 lump sum tax free and £75,000 on which he pays £30,000 (40%) tax, leaving him £70,000 net to invest in…’

It looks right at first glance, but think a bit further:

• If Henry is a higher rate taxpayer, his income must be at least £41,865 in 2014/15 (and £42,285 in 2015/16).

• Add £75,000 to that minimum income and you have at least £117,285 next tax year.

• That is squarely into the territory where the personal allowance is phased out. At best Henry would lose £8,642 of allowance and at worst (if his income is over £46,000 but less than £100,000), his full £10,500 personal allowance in 2015/16.

• Losing the personal allowance in 2015/16 adds £4,200 to Henry’s tax bill (£10,500 @ 40%).

• The extra tax from losing the personal allowance is a tax cost of taking the large withdrawal, which means the tax arising from the withdrawal is not £30,000, but £34,200 – an effective tax rate of 45.6%.

Of course, it is possible to imagine other situations – Henry could be a 40% taxpayer with income of £100,000, in which case adding £75,000 not only wipes out his personal allowance, but also drops him into 45% tax (or maybe 50%, if Mr Balls has his way). Sticking with 45% for now, the £75,000 would cost £35,450 in tax – an effective 47.27%.

Then there’s the high income child benefit charge, which might come into play in some instances…


The tax structure above £100,000 is a classic piece of political design. The only reason we have a £20,000 60% marginal tax band either side of two 40% bands and £30,000 from the additional rate threshold, is that just moving from 40% to additional rate would have brought the additional rate threshold down too close to £100,000 for the liking of politicians. The phasing out of the personal allowance produces the necessary revenue with sufficient obfuscation to fool most of the people most of the time – including some who should not be fooled so easily.

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