Pensions and tax
The greatest benefit of saving for retirement via a pension is that you get tax relief when you pay money in, you get tax-free growth on your investments, and when you take money out after age 55, part of the pension payment will also be tax free. These generous tax breaks are not guaranteed and the tax treatment of pensions can be a bit of a minefield. Read on to learn more but remember that much depends on your own personal circumstances and you should consider consulting a tax adviser if you are in any doubt about what to do.
What tax relief do I get on money paid into my pension?
The general rule for personal contributions is that you make a payment net of basic rate tax and HMRC will pay 20% of the gross amount directly into your pension fund. For example for a £1,000 gross contribution you only need to contribute £800 and HMRC will pay £200. If you are a higher or additional rate taxpayer you can claim extra relief through your tax self-assessment form.
When your employer makes a contribution to your pension the full gross amount is paid into your fund. Employer contributions are tax-deductible expenses, so relief can usually be claimed via the company accounts.
For high income individuals the amount that can be paid into your pension and the tax relief available is tapered as explained in our taper relief guide.
If you are not employed and have no taxable income then you can still contribute a small amount to your pension and receive a top up from the Government. For more information see our contributing to your pension page.
There is a limit to how much you can contribute in your lifetime and tax penalties apply if you exceed this. See the lifetime allowance page for further details.
Can I take some of my pension tax free?
Yes, you can normally take 25% of your pension tax free. See our tax free cash page for details of your options.
How much tax will I pay on my pension?
After taking the 25% tax free cash, the rest of your pension income or lump sum will be subject to income tax. You need to take care if you are taking a large sum of money from your pension as it could push you into a higher rate tax band and the tax paid could therefore be a lot higher than you had thought.
How do I pay the tax due on my pension payments?
Just as when you are working, the PAYE system is used. We must deduct tax using your tax code provided to AJ Bell Youinvest by HMRC.
For more information about tax codes see www.gov.uk/tax-codes
What tax is paid when I first take my pension?
When you first take a taxable income payment or lump sum from your pension or if HMRC has not supplied a tax code then we have to deduct income tax using either the tax code on your P45 or an emergency tax code. If you take out a large amount from your pot this could mean that you overpay tax and will have to claim it back.
What is an emergency tax code?
This is a temporary tax code we use where no tax code has been issued by HMRC or where we don’t have a valid P45.
The emergency tax code works on a “month 1” basis so it assumes that you get one twelfth of the basic annual tax allowance - £11,850 for tax year 2018/19 - each month and any income above that is taxed assuming you will have the same income every month. No account is taken of any other income or tax you may have paid.
For example, if you decide to withdraw £5,500 from your pension pot and have an emergency tax code an annual income of £5,500 x 12 or £66,000 will be assumed and you will pay tax as follows:
|Drawdown income payment – 25% tax free cash already withdrawn||UFPLS lump sum payment – includes 25% tax free
(only applies to parts of your pension which have not already been accessed and the tax free cash withdrawn)
|Band||Amount||Tax due||Amount||Tax due|
|Tax free @ 0%, including personal allowance of £11,850||£988||£0||£2,363||£0|
|Basic rate – £0-£34,500 @ 20%||£2,875||£575||£2,875||£575|
|Higher rate – £34,500 - £150,000 @ 40%||£1,637||£655||£262||£105|
|Additional rate – £150,000+ @ 45%|
|Overpayment – assuming you will actually be a basic rate tax payer for the year||£328||£53|
The personal allowance reduces by £1 for every £2 of income above £100,000, reducing to zero when income reaches £122,000. If your withdrawal multiplied by 12 months puts you over this amount you will pay even more tax. For example, if you decide to withdraw £25,000 and have an emergency tax code, an annual income of £300,000 will be assumed and the tax will be calculated as follows:
|Drawdown income payment – 25% tax free cash already withdrawn||UFPLS lump sum payment – includes 25% tax free (only applies to parts of your pension which have not already been accessed and the tax free cash withdrawn)|
|Band||Amount||Tax due||Amount||Tax due|
|Tax free @ 0%||£0||£0||£6,250||£0|
|Basic rate – £0- £34,500 @ 20%||£2,875||£575||£2,875||£575|
|Higher rate – £33,500 - £150,000 @ 40%||£9,625||
|Additional rate – £150,000+ @ 45%||£12,500||£5,625||£6,250||£2,813|
|Overpayment – assuming you will actually be a basic rate tax payer for the year||£7,420||£5,858|
How do I reclaim any overpaid tax on my pension?
If you have overpaid or underpaid tax you need to settle this directly with HMRC. You can do this via your self-assessment return at the end of the year or you can make a claim for overpaid tax using one of the HMRC forms:
- P50Z – If the payment used up your pension pot and you have no other income in the tax year
- P53Z – if the payment used up your pension pot and you have other taxable income
- P55 – if you have withdrawn only part of your pot and you’re not taking regular payments
The forms are available at www.gov.uk/claim-tax-refund/you-get-a-pension
For further information about your pension options see our SIPP benefits guide