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.
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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)
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.
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.