WHAT GETS TAXED : Tax needs paying any time your total annual income exceeds your current Personal Allowance. Total income can include:
- A personal pension or a workplace pension (some exceptions apply to tax-free lump sums).
- Earnings (e.g. employment or self-employment) and other income sources (e.g. money from property rental, savings, or investments).
- Some taxable welfare benefits (if applicable).
- The UK Additional State Pension.
- The UK State Pension (either the new State Pension or the old version – the basic State Pension).
Note: Taking large amounts can result in paying higher rates of income tax. In some cases, there may also be extra tax owed at the end of the tax year.
Tax if Private Pensions Total over £1.03 Million
As a rule, there is a tax charge if the total value of all your private pensions add up to more than £1.03 million. The charge gets taken of by your pension provider before you receive the payment.
Tax on Inherited Pensions
What is Tax Free?
There is an easy way to work out if you need to pay Income Tax using a calculation. But, as a rule there is no tax to pay when your Personal Allowance is greater than your total annual income.
Lump Sums from a Pension
Taking a tax-free lump sum out of a pension pot does not affect your Personal Allowance. In most cases, the first 25% taken as a lump sum from the built up fund is tax free. The pension provider deducts any taxes due off the remaining amount before you get the cash.
Very few private pension types allow you to take money from them before you reach 55. Your pension provider will confirm the age limit if you are unsure when you can take cash from the pension.
A whole pension pot is worth £80,000. A lump sum withdrawal of £20,000 is tax-free. The pension provider would deduct the tax off the remaining amount of £60,000.
Ways to take a Pension
Pensions worth up to £10,000
There are several different types of pensions available in the United Kingdom. But, in most cases they all allow you to take it in one go if it is not worth more than £10,000.
Your provider or administrator would call this as a ‘small pot‘ lump sum. Taking this option gives you a tax-free amount of 25% and you can usually take:
- A maximum of 3 small pot lump sums from separate personal pensions.
- An unlimited number of small pot lump sums if they are from different workplace pensions.
Pensions worth up to £30,000 and include a ‘Defined Benefit Pension’
The rules change when there is no more than £30,000 in all your private pensions. You can take everything in the defined benefit pension as a ‘trivial commutation‘ lump sum – in most cases. Choosing this option provides you with a tax free amount of 25%.
But, having the lump sum paid from more than one pension means you must:
- Get the savings in each scheme valued by the provider on the same day. This cannot be more than 3 months before receiving the first payment.
- Collect all the payments within 12 months of getting the first payment.
Taking payments from a pension before taking the rest as a lump sum means tax is due on the whole lump sum.
Taking Cash from a Defined Contribution Pension
Your provider will confirm how to take money from your defined contribution pension. But, in most cases you can take:
- The total fund built up in the pension as cash (up to 25% would be tax-free).
- Smaller cash sums from the pension (up to 25% of each sum would be tax-free).
Note: There may be a tax charge on money put into the pension after the cash gets withdrawn.
Life Expectancy Less than One Year
In some cases, you can also take the whole pension pot as a lump sum and tax-free. This is only possible if all the following apply:
- A serious illness means you do not expect to live for longer than one year.
- You are below 75 years old.
- You do not have more than the lifetime allowance in pension savings (currently £1.03 million).
Note: Those who are over 75 years old will pay Income Tax on the lump sum. As always, your pension provider is the main point of contact. Some pension funds will keep at least 50% of the pension pot for a spouse or a civil partner.
How Tax on Pensions gets Paid
Receiving the State Pension ‘and’ a Private Pension
What happens if you are getting the State Pension as well as a private pension? In this case, the pension provider takes off any tax owed before they pay out. Likewise, they would also deduct any tax owing on a State Pension.
Some people get pension payments from more than one provider. You might get one as an occupational pension and another as a personal pension. In this case, HM Revenue and Customs will ask one of the providers to deduct the tax off the State Pension.
Note: The pension provider presents you with a P60 at the end of each tax year. A P60 shows how much tax got paid to HM Revenue and Customs.
Receiving the State Pension as the Only Income
What happens if the State Pension is the only source of income? In this case, you would be responsible for paying any tax owed to HMRC. Thus, owing tax means you must fill in a Self Assessment tax return and send it to HMRC.
Note: The pension rules and regulations changed from the 6th of April 2016. Those who started getting a pension from this date do not need to send in a tax return. Instead, HMRC will write to you informing what you owe and how to pay tax when you get your pension.
If You Carry on Working
Those who continue to work get tax deducted by their employer. They will take any tax that is due off your earnings and off your State Pension. This is a government system of tax collection called Pay As You Earn (PAYE).
Self-employed workers must fill in a Self Assessment tax return at the end of each tax year. You can use the form to declare your total income. This could include the State Pension and any money from private pensions (e.g. a workplace pension).
Having other Sources of Income
Having British citizenship comes with a responsibility to pay all taxes owed to the Exchequer. This also applies to any other income besides money from pensions. Therefore, you might need to complete a Self Assessment tax return.
Note: There are ways to claim a tax refund for anyone who paid too much money in taxation.
Income Tax Codes and Rates
As a rule, you only get one tax code when your income comes from only one source. But, you can have several different tax codes if your income comes from several sources. You can also update your tax code and get it corrected if you think there is an error.
Double Taxation Agreement
What if you live in a country that does not share a ‘double taxation agreement‘ with the United Kingdom? In this case, you may end up paying taxes in both countries.
Income Tax if You Live Overseas
Some things change with tax when you live abroad – depending on whether you get classed as a UK resident or not. Being classed as a UK resident for tax purposes means you may have to pay UK tax on your pension. Your income determines the amount you would need to pay.
As a rule, those who are not classed as a UK resident do not pay UK tax on their pension. Even so, you may need to pay it in the country where you live. Some exceptions apply (e.g. UK civil service pensions will always get taxed in the United Kingdom).
Higher Tax Rate on Unauthorised Payment
Payments made outside government tax rules get classed as unauthorised. Higher tax charges are payable in these situations. If your pension provider makes an ‘unauthorised payment‘ you could pay up to 55% tax. They usually include:
- Payments made before you reach 55 (some exceptions apply when taking early retirement).
- A type of lump sum called a ‘trivial commutation’ if it is over £30,000.
- Regular pension payments made into your account after your death.
Note: Beware of companies with offers of help to get money out of your pension before reaching 55. The system they use can result in an unauthorised payment. You will pay up to 55% tax on unauthorised payments.