Are Pensions Taxable?

Published: 28/06/2018
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Are you approaching retirement age and thinking about your pension? It is possible that when you retire, you may end up paying tax on money that is withdrawn on your pension, but there are a specific set of circumstances as to when this occurs. In this guide, we will take a look at when pensions become taxable, as well as considering tax benefits and the potential repercussions too.

When Do Pensions Become Taxable?

You will be liable to pay income tax on your pension if you meet certain criteria as stipulated by the UK government. These are the following:

  • Your annual income (which also includes your monthly pension) equates to over £11,850, this means that you will also pay income tax on your workplace pension if you have one, as well as the State Pension and any other income such as savings, investments or benefits such as Carer’s Allowance.

  • Your yearly income, which takes into account your pension withdrawal, is over the amount of £11,850. This is the maximum Personal Allowance amount that you have as a pensioner.

  • The amount that you are withdrawing is more than 25% of your pension fund. This means that the first 25% is completely tax free, and then you pay tax on the other 75%. It is important to note that the tax-free amount doesn’t use any of the Personal Allowance that you have.

How Much Tax Will I Pay on My Pension?

When it comes to paying tax on your pension, the tax brackets works in the same way as any other kind of income, the only exception is if your annual income is within the Personal Allowance.

For example, in the current 2018/19 tax year you will need to pay the following for income tax, depending on the earnings category you fall under:

Between £11,850 – £46, 350: as a basic rate taxpayer you will have a 20% tax deduction;

Between £46,350 - £150,000: as a higher rate taxpayer you will have a 40% tax deduction;

Earnings over £150,000: as an additional rate taxpayer you will be paying a 45% tax deduction.

How Does the 25% Tax-Tree Allowance Work?

In terms of the 25% tax-free amount you receive, you have different ways of taking it. For example, you have the opportunity of taking it as a lump sum, paying no tax on it. If you do decide to go with this option, it is possible for you to leave the remaining 75% invested until you decide to retire. Alternatively, if you wish to draw your pension immediately you will need to either get an adjustable income (flexi-access drawdown), buy a guaranteed income (known as annuity), or you could decide to take the entire pension pot as cash and pay tax on the remaining 75%.

An example of how this works: if you had a pension pot of £60,000 and you decide to take £15,000 of it, this will be your lump sum that isn’t taxable. With the remaining amount of £45,000 you could buy an annuity either from your existing provider or decide to look into the open market option to achieve a better rate and depending on your total annual income this would dictate if you had to pay tax on your pension income or not.

Another example: you take small amounts out of your pension pot without paying tax on 25% of individual payments. So, this means that if you had the same amount as in the previous example (£60,000) but decided to take out £1,000 monthly, £750 of this amount will be taxable.v

Tax Relief on Private Pension Contributions

It is possible in the UK to receive tax relief on private pension contributions, which means that it can either increase the pension fund that you have or provide you with a lower tax bill. Your maximum contribution for this tax year, made before April 5th, is £40,000. This figure must include tax relief and any employer contribution. However, you cannot pay more into your pension than you have earned in a given year.

There is an annual limit when it comes to the amount of tax relief you will receive. This will be deducted automatically without you needing to do anything if:

  • You have paid a rate of income tax at 20%, as your pension provider will add this to your pension pot claiming it as tax relief

  • Your employer withholds workplace pension contributions out of your salary prior to taking out income tax

For the tax year in 2018-19, you will receive income tax relief on pension contributions up to 100% of your earnings limited to a maximum of £40,000. This is providing that you are under the age of 75.

Amounts over this will not be subject to tax relief, but any unused allowances from the last three years (providing that you were a member of a pension scheme during this time) can be carried forward. The only exception is if you have a defined contribution pension, or if you have an income including pension contributions over £150,000

How Much is it Possible to Build up in Your Pension?

There is a lifetime allowance that is in place which puts a limit on the value of pension benefits that you can receive without having to also pay a tax charge. Currently, this amount is £1,030,000. This means that any value over this amount will be taxable at 25% if it is paid as a pension, rising to 55% if it is paid out as a lump sum.

This means that you are also responsible for paying tax on other income such as investments or property and you will most likely need to fill out a Self-Assessment tax return in order to sort this out.

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