Worth knowing the fine detail of taxation and pensions as you look to retirement
Although you don’t get taxed when building up savings, pension income is subject to income tax
Ireach state pension age soon and I am planning to give up work altogether when that starts coming in. How will my tax affairs change? Am I right in thinking that I don’t pay tax on my state pension?
Thanks to the UK’S rather byzantine ways of applying tax to our income earnings, you could, depending on your situation, be both wrong and right about the taxation of your state pension. When you save into a private pension, you do so on an ‘exempt, exempt, taxed’ or EET basis. This means that your contributions into a pension get tax relief, and the investments into which your pensions are placed do not get reduced by income tax, dividend tax or capital gains tax.
The government views this lack of taxation as a significant incentive for you to take financial responsibility for your future by saving into a pension – although you don’t get taxed when you’re building up your savings, your pension income is subject to income tax.
The state pension is a benefit, which is paid to you without tax deducted (or ‘gross’). However, unlike many other benefits, it is treated as taxable income. That doesn’t necessarily mean you will pay any income tax. That will depend on the amount of private pension you receive. That’s because we each have a personal tax-free allowance, an amount of money we can earn
before we pay any income tax. In the 2021/22 tax year, that is £12,570.
Let’s say you're getting the full amount of the weekly state pension, which is £179.60 per week in the 2021-22 tax year (which started yesterday). That’s the equivalent of £9,339.20 per year. So, if the state pension was your only income in retirement, you would pay no income tax as
your pension income was lower than the personal allowance. Things get a bit more complicated when you have a private pension, or income from any other sources (such as a rental property or parttime work). Your state pension will use up most of your personal allowance. In our scenario above, it means that the first £3,171 of income you get from your private pension can
be earned tax free, with anything above a total of £12,570 subject to income tax.
The next £37,700 will be taxed at 20%. Income between £50,000 and £150,000 is taxed at 40%, and anything above £150,000 is taxed at 45%.
These are the tax rates for England, Wales and Northern Ireland. Rates in Scotland are slightly different. Income above £12,570 and below £14,667 is taxed at 19%, between £14,667 and £25,296 taxed at 20%, and income between £25,296 and £43,662 is taxed at 21%. The income between £43,662 and £150,000 is taxed at 41% and income above £150,000 is taxed at 46%. If you have a private pension, you’ll likely be contacted by HMRC when you start getting your state pension. Some new pensioners report getting lots of letters from HM Revenue and Customs (HMRC) about changes to their tax code when they first collect their state pension. This may be because you have income from more than one pension. If the state pension is the only income you have, you’ll need to complete a self-assessment tax return.