A taxing time for retirees
MORE than nine million pensioners face an income tax bill over the next 12 months, and for many the tax demand will come as a shock.
Roughly three quarters of pensioners will pay income tax this year, of whom 650,000 may be doing so for the first time since they retired.
Two successive state-pension triplelock increases of 10.1 per cent and 8.5 per cent, combined with the freeze on income tax allowances, are dragging more into HMRC’s clutches.
With the new state pension paying up to £11,501 a year from Monday, retirees only need a small amount of income from other sources to breach the £12,570 personal allowance and pay income tax.
Stephen Lowe, director at retirement specialist Just Group, said the number of pensioner taxpayers will keep growing with the personal allowance frozen until the 2027/28 tax year.
“The nightmare scenario is that someone unexpectedly finds they owe tax plus penalties for late payment.”
HMRC doesn’t tax the state pension, so any money you owe will be deducted from other sources. Further complicating matters, it does this in two different ways.
First, income from a defined benefit “final salary” company pension, annuity or drawdown is taxed automatically under Pay As You Earn.
The second method of withdrawing tax could cause even bigger problems. The state pension, dividends on shares or interest on savings held outside of a tax-free Isa, as well as profits from self-employment and rental property, are usually paid before tax, Lowe said. “The onus is then on you to give HMRC the right information and pay the correct amount of tax.”
Typically, you must do this by filing a self-assessment return.Visit Gov.uk/ check-if-you-need-tax-return to see if you need to register.
Consider signing up for a Government Gateway account, which lets you check your state pension, income and Tax Code.
Self-assessment is partly based on estimates or previous tax returns, which means people can pay too much or too little, Lowe warned. “Sometimes, tax missed one year can be collected next year without penalty. In other cases, penalties and demands can be immediate.”
As the state pension edges closer to the personal allowance, retirees will see income from other sources fall as HMRC deducts more tax, said Andrew Tully, technical services director at Nucleus Financial.
Keeping your Tax Code up to date isn’t easy, especially if you have multiple sources of income. Every time something changes, it will impact your code.
Tully said: “If you are underpaying you will get a big demand at some point. Overpaying isn’t ideal either.”
People who have never paid tax in retirement could struggle to use HMRC’s Byzantine systems.
Just one example is the way HMRC charges someone making a one-off drawdown withdrawal as if they are taking it every month of the year. Often people caught out pay tax they do not owe and have to claim it back or wait for HMRC to adjust their Tax Code at the end of the financial year.