The basic problem why things often go wrong with your tax code around retirement is that the Department for Work and Pensions, unlike every other employer and pension payer in the land, do not operate PAYE on your state retirement pension. This forces the PAYE system to do something which it is not very good at, which is to collect tax on two sources of income through one tax code (usually collecting tax on both the state pension and an occupational pension through the coding issued for the occupational pension).
HMRC processes when the state pension starts
HMRC will be notified automatically by the Department for Work and Pensions once you have decided to claim your state pension as long as they have a record for you. However, it may be as well just to let them know so that they can ensure their records are correct.
Your tax office is advised automatically about five weeks before the date when you reach state retirement age. They will issue a form P161 to you to fill in and send back - you can also download the form. Once they have the completed form they can then adjust your occupational pension coding notice to take account of your state pension.
However what can and does happen is that whilst your higher personal allowance is available for the whole of the tax year you reach age 65, HMRC will only include it in your coding notice once they have received the completed form P161. For anyone whose birthday falls near the end of a tax year this means a long delay in getting these additional allowances.
It is worth trying to get your coding changed earlier by advising your tax office at the start of the tax year in which you will become 65, that you will be 65 at some point during that tax year and that you would like your coding notice changed straightaway. You may need to give HMRC an estimate of your income so that they can calculate the amount of allowance to give you.
In the first year you get your state pension, you will more than likely receive payment for only part of the year. How this is then taxed depends on whether you already get the higher personal allowance for those over the age of 65 or whether you start to receive the allowance in the same year you first get your state pension:
If you already receive the higher personal allowance
If you already get the higher personal allowance (because you are 65 or over), HMRC will normally include a full year's pension in your coding notice and then tell your employer or pension payer to use a special type of code (called a week 1 or month 1 code) to make sure that you only pay the right amount of tax.
If you are unhappy with this, ask HMRC to include the correct amount of state pension that you will be receiving in that tax year - tell them what you think the amount should be and then check the revised coding notice when you get it.
| Example Wes had his 69th birthday on 1 October 2012 during the 2012/13 tax year. He started to receive his state pension of £6,500 per year from that date as he had deferred his state pension while he worked. His total income on which he will pay tax is £13,000 including the state pension. Whilst he will only actually receive around £3,250 pension in 2012/13 (6 months worth) - the full £6500 will be shown in his coding notice and his pension payer will operate a special tax code to make sure Wes is in fact only taxed on £3,250. If Wes does not like this arrangement he can contact HMRC and ask them to include £3,250 in his coding instead. The special coding will not then apply.
|
Receiving the higher personal allowance at the same time as the state pension
However, if you will be receiving the higher personal allowance for the first time in the year you start to get the state pension, you will only be taxed on the actual amount of state pension you receive in that tax year. Any underpayment of tax that might arise because you have not paid enough tax on your state pension will be included in your coding notice for the following tax year.
| Example If instead Wes was 65 on 1 October 2012 so that he started to get his higher tax allowance for the first time in the 2012/13 tax year and he also started to receive state pension, only six months state pension of £3,250 will be included in his coding notice for 2012/13. If this means that Wes will have not have paid enough tax on his state pension for 2012/13, the underpayment will be included as a restriction in his tax code for 2013/14. |
Incapacity benefit
Incapacity benefit (IB) is being replaced (by employment and support allowance) over the years 2010 to 2014 but if you reach retirement age whilst you are still on IB and you are one of those people who received their IB in the transition from the former invalidity benefit at 12 April 1995 then you will experience a change in your tax status. If you received this long-term IB for the same incapacity that existed back in 1995 your IB will have been tax-free. However when you reach state retirement age you lose IB and start to receive the state pension which is taxable.
Bear in mind that if you were a non-taxpayer when you received IB you may now be liable to pay some tax if your income is more than your personal allowance. If this is the case and you had registered to receive your interest on any bank and building society accounts before tax was taken off - you will now need to deregister so that tax is taken off your interest before you get it.
More than one pension source
When you start getting your pensions, you may have more than one occupational or personal pension. Each pension will need its own coding notice and you should check them to make sure that they are correct.
With more than one coding notice you need to make sure that you are not getting too many or too few allowances by looking at all your coding notices together. You can see what allowances you should be entitled to in total by referring to the sections on tax allowances and special allowances and then use this to help you check the forms.
You should also be aware that many adjustments caused by employment (such as taxable benefits, special work allowances or subscriptions) may need to be reduced in the final year of work.
In the second year after retirement make sure that any adjustments that were due in earlier years from your prior employment are not being simply carried forward (just because you had them last year).
Finally, bear in mind that in the first year you receive state pension you may have your personal allowances reduced because the extra income takes you over the limit above which the higher personal allowances are restricted - for 2012/13 this will be £25,400. This type of situation will often apply if you were still working during that year, but the same problem could also reoccur if you continue in work in later years
Make sure the HMRC calculation of this on your coding notice is correct by asking them to explain to you how they have worked it out. Alternatively, you can read our summary setting out how the rules work.
Back to the top
