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From 6 January 2024, the main rate of class 1 National Insurance contributions (NIC) deducted from employees’ wages is reduced from 12% to 10%. From 6 April 2024, the main rate of self-employed class 4 NIC will reduce from 9% to 8% and class 2 NIC will no longer be due. Those with profits below £6,725 a year can continue to pay class 2 NIC to keep their entitlement to certain state benefits. Our guidance will be updated in full in spring 2024.

Updated on 6 April 2023

Pension income: impact on state benefits

There are many things to think about when you start drawing a pension, as the additional income you receive can have a knock-on effect on other areas of your finances. Here we look at the potential impact on any state benefits that you might be claiming.

Content on this page:

Introduction

On our page Pension withdrawals: thinking ahead we discuss some of the ways that drawing a pension can affect your overall tax position. On this page we look at how pension income can effect any state benefits you might be entitled to – or might cause inadvertent charges to arise. These can apply regardless of how you choose to draw your pension – so for example if you are drawing pension income as an annuity or making flexible withdrawals.

In some cases, any commencement tax-free lump sum can also have an effect on your entitlement, particularly if you are claiming universal credit, as ‘capital wealth’ is taken into account when calculating your award, regardless of whether it was taxable or not when you initially received it. We discuss this below under the heading ‘Other state benefits’.

Tax credits claims

Taxable income from pensions is also income for the purposes of tax credits. The tax-free element of any pension income or lump sum is not included as income for tax credits.

Taking money out of a pension could therefore mean you end up with a tax credits overpayment for the year in which you take the money out – this means that you may have been paid too much and have to pay it back.

It could also mean you end up with less tax credits in the following year as well. This is because tax credits are worked out using yearly rates and yearly income figures. Your income may well change from one year to the next but only changes over or under certain limits will alter the amount of tax credits you were awarded at the beginning of each tax year. The limits for changes in income from one year to the next are known as the income disregards.

You do not actually have to tell the Tax Credit Office about changes to your income until the end of the tax year when HMRC finalise your award, but you might wish to tell them sooner about money taken from a pension in order to reduce the amount of any overpayment.

Other state benefits (including universal credit)

You should carefully check the impact of your pension decisions on means-tested state benefits, such as universal credit and pension credit.

One-off or irregular sums taken from pensions could be treated as capital for the purposes of means-tested state benefits, and regular amounts taken from pensions are likely to be treated as income. Either capital or income treatment could have an immediate effect on your entitlement to state benefits, depending on your overall circumstances.

Local benefits like council tax reduction could also be affected.

It is not only the decision to take money out of a pension that could impact your current or future entitlement to means-tested state benefits. There could also be knock-on effects depending on how you use the money once you take it out. For example, if you were to decide to give pensions money away, for the purposes of state benefits (such as help with care costs) it might be considered that you deprived yourself of your pension savings.

We therefore recommend that you check your situation carefully before taking money out of your pension. There is some guidance from Moneyhelper on state benefits impacts. The Department for Work and Pensions have also published a factsheet, available on GOV.UK – this considers how the pension flexibilities could affect entitlement to state benefits.

Child benefit claims

Taking money out of pensions can have unexpected consequences for child benefit purposes.

Unlike the benefits discussed above, child benefit is not in itself a means-tested benefit. This means that anyone with qualifying children can claim it. But there is a linked tax charge on some recipients of the benefit, or on the recipient’s partner if they are part of a couple, where income is over £50,000 in the tax year. This is called the ‘high income child benefit charge’ (HICBC).

We explain child benefit and the HICBC separately on our website. It is not something that most people on low incomes usually have to worry about, but it could become a problem for people taking sums out of their pension pot (particularly under the pensions flexibility rules) if that tips their total income over the £50,000 limit.

Note that the charge is applied for the tax year, so if, for example, you take a pension withdrawal in March 2024 and it takes your adjusted net income over £50,000 for the year, the charge will apply to any child benefit payments you receive across the whole tax year (6 April 2023 – 5 April 2024), not just those after your income tips over the £50,000 threshold.

You may not usually have income anywhere near £50,000 a year. But that could change if you take a taxable pension lump sum. Any tax-free lump sum is not counted towards the £50,000 threshold – only taxable receipts.

Example: Peter and his family

Peter earns £22,000 a year. He is 55 and has built up a pension fund of £50,000. His wife, Sue, is 42 and does not work. The couple have two young children, aged 3 and 5.

Sue claims child benefit totalling £39.90 a week. This works out to £2,075 for the 2023/24 year – you can check the amount of your child benefit for a tax year using the calculator on GOV.UK.

Peter wants to cash in his pension to pay off his £47,000 mortgage.

If Peter takes the full pension fund at once, he gets 25% of the £50,000 tax free – £12,500. He would have to pay tax on the rest – £37,500. The income tax on this without including the high income child benefit charge works out to £9,346. See note 1 below to see how this is worked out.

Furthermore, Peter has to pay a high income child benefit charge based upon total income of £59,500 (£22,000 plus his taxable lump sum of £37,500). This works out to additional tax of £1,971. See note 2 below to see how this is worked out.

Also, Peter and Sue lose the ability to claim the marriage allowance for 2023/24. This costs them a further £252 in tax.

 

So what is Peter’s total tax cost when cashing in his full pension in 2023/24?

Income tax £9,346
Lost marriage allowance £252
High income child benefit charge £1,971
Total cost £11,569


This means that of the total £50,000 pot, Peter will have just £38,431 left after tax charges. He will not have met his aim of paying off his £47,000 mortgage! And note that this does not include possible lost tax credits or other benefits, which might be a further significant cost of cashing in his pension – see note 3 below.

Added to that, Peter will have to register for self assessment and fill in a tax return so that he can pay the high income child benefit charge to HMRC.

Note 1: income tax calculation on Peter’s pension lump sum

The £37,500 is added to his salary of £22,000, which comes to £59,500.

His salary has already used up his personal allowance (tax-free amount for the 2023/24 year) of £12,570. It has also used up £9,430 of his basic-rate tax band (the amount on which he pays tax at 20%).

Peter’s remaining basic rate band is therefore £37,700 minus £9,430 = £28,270. The tax on that part of the pension lump sum at 20% is therefore £5,654.

The rest of the pension lump sum is taxed at the higher rate of 40%. This is therefore £37,500 minus £28,270 taxed at basic rate; so that leaves £9,230 at 40% which works out to be £3,692.

The income tax bill is therefore £5,654 plus £3,692 which works out to be £9,346.

This is before adding in the high income child benefit charge or considering the loss of the marriage allowance.

Note 2: high income child benefit charge (HICBC) calculation

The HICBC takes away 1% of child benefit for every £100 of income over £50,000. Peter’s total income is £59,500 (his salary of £22,000 plus the taxable part of the pension cashed in, £37,500). As Peter’s income is £9,500 over £50,000, the charge is 95% of their child benefit. So 95% x £2,075 is £1,971 (rounded down).

Note that we have assumed that Peter has not paid any pension contributions in the 2023/24 tax year. If he had have done, this could affect the income figure on which the HICBC is based, as the calculation uses adjusted net income.

Note 3: tax credits impact for 2023/24 and 2024/25 claims

The above calculations do not include the impact on Peter and Sue’s tax credits claim. But if they do claim tax credits, there will be an impact, as the taxable part of the pension also counts as tax credits income. This means that they could lose all of their tax credits for the 2023/24 year.

Tax credits for the 2024/25 year can be affected by an increase in income for 2023/24. This is because even if Peter and Sue’s income goes back to £22,000, they will be treated as having £24,500. This is because of what are called income disregards. You can read more about this on our tax credits page What changes do I need to report?

Scottish Child Payment

The Scottish Child Payment for low-income families with children under six started on 15 February 2021. This payment is being described in some places as a ‘child benefit top-up’. To be eligible, you will have to be in receipt of a qualifying benefit such as universal credit or any of its legacy benefits, such as working tax credit or child tax credit.

The Scottish Child Payment is separate from child benefit. However, drawing on your pension may mean that you lose entitlement to both the Scottish Child Payment and the associated means-tested benefit on which your eligibility s based.

If your adjusted net income exceeds £50,000, you may also effectively lose some or all of your child benefit via the high-income child benefit charge, as discussed above.

The HICBC does not apply to the Scottish Child Payment.

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