Tax on Pensions
Do you understand the tax rules around your pension?
What is tax relief? Do I pay tax? How does it work?
Tax on Private Pensions
By putting money into a pension, the Government will provide “tax relief” meaning they will put some money in too – giving your savings a boost straight away! For example, if you put £100 into a pension, the Government will add a further £25 meaning you have £125 straight away! If your lucky enough to a higher rate taxpayer, you can even reclaim a further £25 via self-assessment! There are limits on how much you can pay into pensions:
Those limits being:
Annual Allowance – This is the maximum you can save into your pension in a given tax year. Currently this is £40,000 per annum. You will pay the tax relief back if you go over this amount.
This allowance may be reduced if you take money out of your allowance and dependent on how you take it. Care is needed as in some circumstances you can trigger the Money Purchase Annual Allowance (MPAA), resulting in a reduced allowance of just £4,000 per year.
Read more – link to MPAA page
Lifetime Allowance – This is the maximum amount you can save into pensions during your lifetime. If your total pensions are worth more than the allowance (currently £1,073,100) there will be a tax charge of either 25% or 55% depending on how you withdraw the excess!
Tax Relief – This is what is referred to when the Government “”tops up” your pension.
Tax-free Growth – Your pension will also grow tax-free along the way meaning your money should grow faster as the tax-man is not “taking a cut” along the way!
More on Tax on your Pensions read the government website
Health warning: Taxation is different to each and every person reading this so it is very important you get personalised advice!
The two types of payment from a pension fund are:
Tax free lump sum / Pension commencement lump sum
Final Salary pension scheme – provided by a calculation which the scheme itself completes. We call this calculation “commutation”.
A personal or individual pension – Usually 25% of the fund value at the point of “crystallisation”. Be aware however, some older schemes may have “protected tax-free cash” which will allow more than the standard 25% to be drawn tax-free. The “enhanced” or “protected” tax free cash could be anything above 25%, including even 100%!
As the name suggests, these payments of tax-free cash (within the Lifetime Allowance) are paid tax-free
Taxable income / scheme income / annuity income / drawdown income
All UK pension schemes, whether occupational (from group / workplace arrangements) or personal (from individual arrangements) will pay taxable pension income via a PAYE system. Basically, they will try to deduct the correct amount of tax before payment is made to the member (you) and pay this across to HMRC on your behalf. this avoids complicated paperwork such as self-assessments.
HMRC will provide the payroll operator with a “tax code” based on the members individual circumstances. (all in a very similar way to how an employer would pay your wages)
When could I pay more tax? (Emergency tax codes)
When you receive your first income payment from your pension provider, they will then notify HMRC that you should now be included in their payroll records. HMRC should then send the correct tax code for the payroll operator to use. As this can take a little time (usually 2 or 3 months), pension income providers will use what is known as “Emergency month 1 basis” until this is received. Result – you will probably pay too much tax!
This means, the pension company will test each individual payment against one-twelth (1/12) of the personal allowance. Where you have had any other taxable income payments in the tax year, for example another pension or salary for example – this will result in overpayment of tax. When the “tax coding” catches up, this should subsequently be corrected, however to speed this up you can complete a “P55 form”.
Other points to consider
- Scotland and Wales now have additional rates of tax payable but during the time where no tax code has been received, the English rates will be used initially.
Summary of Taxation
- Get Tax Relief (free money on your contributions
- Any growth is also tax free
- At retirement, Take your 25% tax free cash
- Reduce tax on income using your personal allowance
- At retirement, the remaining funds (after tax-free cash) are drawn subject to tax.
Pension Tax Frequenty Asked Questions (FAQ’s)
- Do I have to pay tax on my pension?
- How does tax-relief work?
- Can I avoid paying tax on my pension?
- What percentage of your pension is tax free?
- How do I calculate tax on my pension?
Ready to build your Financial Fortress?
Speak to one of our specialist pension advisers today! We will go through your options in more detail and help you build a tailored plan based on your circumstances to ensure a successful retirement!
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