Tax when you receive a pension
6 mins
Our experts at DSR Tax Refunds know how hard it is to find good, quality information about HMRC’s tax regulations that is easy to understand, and that’s why we have created these handy guides to tell you everything you need to know. Our aim is to make life easier for our clients and that is why we want to share our expertise with you. You can also call our friendly team on 0330 122 9972 – we’re the tax experts you can trust. Or you can check out our online calculator to see if you could be due a refund.
How is your pension taxed?
If you receive a pension and your total income is higher than your tax-free Personal Allowance (currently £11,500 for tax year 2017/18), you will be subject to Income Tax.
Your total income includes the following forms of income:
- Your State Pension (whether it is the basic State Pension or the new State Pension)
- Any Additional State Pension you receive
- A private pension – personal or workplace (some of this you will be allowed to receive tax-free)
- Any earnings you get from a job or self-employment
- Any taxable benefits you receive
- Any other income you might receive, for example from investments, savings or rental income.
If you take a large amount from a private pension, you might be liable for Income Tax at a higher rate. You might also owe extra tax at the end of the tax year.
If your private pensions total more than £1 million, you will usually be required to pay a tax charge under the Lifetime Allowance regulations. Your pension provider will deduct this charge before you receive the pension.
If someone else inherits your pension, they (or your estate) might be liable to pay additional taxes.
What is tax-free in pensions?
If your total income, including your pension, is less than your tax-free Personal Allowance, you won’t usually pay any tax.
You can usually take up to 25% of the amount you have built up in your pension as a tax-free lump sum. This lump sum won’t affect your Personal Allowance. Tax will be deducted from the remaining amount left in your pension before you receive it.
At what age you are allowed to take your pension all depends on the rules of your pension scheme – the earliest you can take a pension is usually 55. If you take anything from your pension before you are allowed to, it will be classed as an unauthorised payment.
If you take a large amount from your pension as a lump sum, you might have to pay Income Tax at a higher rate and you may also owe additional tax at the end of a tax year.
How are you allowed to take your pension?
How you are expected to take your pension depends on how much the pension is worth.
For pensions worth up to £10,000
You are usually allowed to take these pensions in one go – these are called ‘small pot’ lump sums. If you decide to take this option, 25% of the lump sum is tax-free. You can usually get up to 3 small pot lump sums from different personal pensions or unlimited small pot lump sums from different workplace pensions.
For pensions worth up to £30,000 that include a defined benefit pension
If the amount saved in all your private pensions is £30,000 or less, you can usually take everything you have in your defined benefit pension as a ‘trivial commutation’ lump sum, where 25% would be tax-free.
If this lump sum comes from more than one pension, you must meet the following conditions:
- Your savings in each scheme must be valued by the provider on the same day, no more than 3 months before you receive the first payment
- You must get all payments within 12 months of receiving the first payment.
If you take payments from a pension before receiving a lump sum, you pay tax on the whole lump sum.
Cash from a defined contribution pension
You need to check with your pension provider about how you can take money from a defined contribution pension scheme. You might be able to take cash in the following ways:
- All the money in your pension as cash – up to 25% is tax-free
- Smaller cash sums from your pension – up to 25% of each cash sum is tax-free
You may have to pay tax on any contributions you make into your pension once you have started to withdraw cash from it.
What happens if your life expectancy is less than a year?
If you are under 75, you might be able to take all your pension money as a tax-free lump sum if the following conditions apply:
- You’re expected to live for less than a year due to serious illness
- Your pension savings are less than the lifetime allowance of £1 million.
If you are over 75, you will have to pay Income Tax on the lump sum.
You need to check the rules of your pension scheme – some schemes will keep 50% of the pension for your spouse or civil partner.
How do you pay tax on your pension?
The way you pay tax on your pension will depend on what type of pension you receive. If you pay too much tax on your pension income, you can claim a tax refund.
You will have one tax code if you only get income from one source. If your income comes from more than one source, you might have a number of different tax codes. If you think your tax code is wrong, you can ask HMRC to correct it.
If you receive the State Pension and a private pension
Your pension provider will deduct any tax you owe before they pay your pension to you, including any tax you owe on your State Pension. If you receive pensions from more than one provider (such as a personal pension and a workplace pension), HMRC will ask one of them to be responsible for deducting the tax from your State Pension. You will receive a P60 at the end of each tax year showing how much tax you have paid.
If you only receive the State Pension
If this is your only pension income, you will be responsible for paying any tax you owe through the Self Assessment system. If you started to receive your pension on or after 6th April 2016, you won’t need to send a Self Assessment tax return because HMRC will write to you to tell you how much tax you owe and how to pay it.
If you continue to work
If you are still working as well as receiving a State Pension, your employer will deduct any tax you owe for your pension through the PAYE system, in the same way as for your employment earnings. If you are still self-employed and receiving a State Pension, you will declare your pension income along with the rest of your income through your Self Assessment tax return.
If you have other income
It is your responsibility to declare any other income you receive and pay the tax on it. You will usually do this through a Self Assessment tax return.
How is your pension taxed if you live abroad?
If you are classed as a UK resident but live abroad, you will most likely still be expected to pay UK tax on your pension – how much you pay will depend on how much income you receive.
If you’re not classed as a UK resident, you usually don’t pay UK tax on your pension but you might have to pay in the country you are classed as resident in. there are some exceptions to this rule – for example, UK civil service pensions are always taxed in the UK.
If you live in a country which doesn’t have a ‘double-taxation agreement’ with the UK, you might have to pay tax in both countries.
How are unauthorised payments taxed?
If your pension provider makes an ‘unauthorised payment’ to you from your pension, you will pay up to 55% tax on that. These payments are payments made outside of the government’s tax rules on pensions. They include most payments made before you reach the age of 55, trivial commutation lump sums of more than £30,000 and regular payments into your pension account after you’ve died.
You might see some companies advertising loans and cash advances based on taking your pension early – be warned that these will be classed as unauthorised payments and you will have to pay tax on them.
How can DSR Tax Refunds help?
We aim to make life as simple as possible for our clients and that includes giving you the information you need to make your taxes (and your life) simpler and less stressful. Our team of experts at DSR Tax Refunds are always on hand to help our clients and our excellent standing with HMRC means that we can make sure you don’t fall foul of their regulations, while claiming your maximum tax rebate. We can even take care of all that paperwork and deal with HMRC on your behalf too. Call our friendly team on 0330 122 9972 – we’re the tax experts you can trust.