How to collect your pension plan

We explain a series of aspects to consider before collecting your pension plan

When the time comes to retire, it is also time to think about the best way, in financial and tax terms, of redeeming the capital you have built up in your pension plan. It is time to enjoy those contributions made periodically over the years, but in order to get the most out of them it is important to consider not only how we are going to recover that money, but how much we really need.

Because the longer the capital stays in the pension plan, the more profitable it will be, so if the retired customer does not really need to touch the earnings they have achieved in the plan, they do not have to redeem them as soon as they retire. There is no obligation to redeem the pension plan upon retirement. Indeed, you could even never redeem it and pass it on to beneficiaries or heirs. This is an option chosen by some retirees that consider that, in planning their income and expenses, they do not need to use the pension plan and prefer to leave it as savings for possible future unforeseen needs.

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To save on taxes, it is recommendable not to redeem the plan in the same year as retirement, in order not push up the amount of taxable earnings, which will be higher than in a financial year in which you have been retired for 12 months.

Is important also emphasize contributions can still be made into a pension plan after retirement. From the moment you start to collect payments from the plan, any contributions made cannot be redeemed due to the contingency of retirement and may only be used for another type of contingency, such as dependency or death.

But before talking about the taxation of the incomes derived from pension plans, it is worth analyzing what types of redemption there are.

Types of redemption of a pension plan

Regardless of the way in which you decide to recover the money contributed to the pension plan, as well as its possible returns, it is important to know that this capital will be taxed as employment income, just like a salary or the state pension would be. This means that the more capital is redeemed, the larger the taxable income base on which the customer will have to pay Personal Income Tax will be.

Therefore, the taxation of the redemption of the pension plan will be linked to the collection method chosen:

Redemption in the form of capital

The full amount of the contributions made to the pension plan and any possible returns generated is recovered. The capital plus returns make up the so-called consolidated rights and when they are recovered in a lump sum, they are also taxed all at once through Personal Income Tax. Redeeming the plan this way will, in most cases, mean having a higher rate of tax due to a higher taxable income base.

Regardless of the way in which you decide to recover the money contributed to the pension plan, as well as its possible returns, it is important to know that this capital will be taxed as employment income, just like a salary or the state pension would be. This means that the more capital is redeemed, the larger the taxable income base on which the customer will have to pay Personal Income Tax will be.

Therefore, the taxation of the redemption of the pension plan will be linked to the collection method chosen:

Redemption in the form of capital

The full amount of the contributions made to the pension plan and any possible returns generated is recovered. The capital plus returns make up the so-called consolidated rights and when they are recovered in a lump sum, they are also taxed all at once through Personal Income Tax. Redeeming the plan this way will, in most cases, mean having a higher rate of tax due to a higher taxable income base.

Redemption in the form of income

If you choose to recover the money contributed to the pension plan this way, the title holder will receive the capital in the form of a periodic income. In the case of financial incomes, these will be received for as long as the consolidated rights last. In the case of lifetime annuities, they will be received until the beneficiary's death.

The holder can select how often to receive the income, which may be monthly, quarterly, half-yearly or annually.  Therefore, it is possible to calculate what the taxable income base on which Personal Income Tax will be charged is going to be. It is worth remembering that the money received from the pension plan is added to the money that comes from the public pension and that the sum of both will be what determines the amount of tax to be paid, hence it is necessary to carefully study what amount of capital it is best to receive from the pension plan.

This type of redemption is interesting if you want to continue to obtain a return on the money deposited in the plan, which will continue “working”, and if you really do not need all the available capital. In terms of taxation, this option usually has a lower impact.

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Mixed redemption

Last of all, there is a type of redemption that combines the two previous types. The title holder of the plan receives a set amount, and subsequently receives the rest of the money in the form of incomes over whatever period has been stipulated.

Flexible redemption

The beneficiary freely chooses the dates and amounts of the withdrawals, without any set frequency.

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