Tax on pension income
On this page we look at what pension income is taxable and provide an overview of how it is taxed.
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Some typical types of pension income you might have are:
- occupational pensions – income from these pensions is almost always taxable;
- personal pensions – income from these pensions is almost always taxable;
- state pension – this pension income is taxable, even though it is paid without deduction of tax at source;
- state pension lump sums: arising as a result of deferral of a pre-6 April 2016 state pension – the tax position is complex;
- pension credit – this is not taxable.
The tax system has many exceptions, so you should also look at our page What pension income is tax-free?. This is where we talk about payment of the 25% tax-free commencement lump sums.
How tax is paid
As mentioned above, the state pension is taxable but has no tax deducted at source. We discuss how tax is collected on state pension income in our page How tax is collected on the state pension. We look at state pension deferrals and the taxation of state pension lump sums here and here.
If you receive a regular income from your private pension, the income you receive is taxable on you.
Your income will be taxed before you get it, under PAYE. HMRC tell your pension payer how much your tax allowance is and how much tax to take off your pension before paying it to you. They send you a coding notice, also known as form P2.
You only pay tax on the balance of your pension after tax allowances are taken off. If you were employed before retirement, you will see that it is the same system which was applied to your wages or salary.
The main problem on retirement is that your PAYE tax codes can get confusing. HMRC might get them wrong initially when you start to draw a pension, either from the state or privately, and you might even be continuing to work, so you have several sources of income. HMRC make assumptions about your retirement income to work out your PAYE codes, so you need to check them carefully. See our page PAYE on pensions.
You might also be able to take lump sums or irregular amounts from a pension, rather than a regular pension income. We discuss these in our page Pensions flexibility. Whichever pension choices you make, you need to watch out for how you will be taxed – so please read our Pension withdrawals: thinking ahead.
If you take lump sums out of your pensions, you might find there are added complications with how PAYE taxes the money you take out. Read our separate guidance on Pensions flexibility.
Tax on pensions after death
You will note that in the overview we have that personal and occupational pensions are almost always taxable. It is sometimes the case that drawing income from these pensions is not taxable if the pension is inherited. For information about what happens to your pension after death, and how it is taxed, see our page Pensions and life assurance on death.
Arrears of private pensions
If a private pension company realises you have not been paid enough pension for previous years and makes a back-payment to you, they will normally deduct tax from that payment in the tax year it is paid. If the back-payment is sizeable, this could push you into a higher tax band and may mean that you are paying more income tax than if you had received the correct level of pension in the tax years that the payments relate to.
In this case, HMRC say you can ask them to spread the payment back to the relevant tax years and recalculate your tax position.
The recalculation will work in a similar way to the calculation of state pension arrears shown here. However, there is no 4 year ‘look back’ limit. HMRC’s guidance says they will recalculate the position for all tax years that the payment relates to.
If you receive a payment of arrears from a personal or occupational pension and would like HMRC to spread the payment back and recalculate your tax position, you will need to contact them to request this – the process is not automatic. Your pension provider should be able to provide you with a statement setting out the tax years to which the back-payment relates.
If the pension provider pays you interest as compensation for the pension error, then this would be taxable in the year of payment and could not be spread back. Check any letter you receive from your pension provider to make sure you are clear what part of the payment is back-payment of pension, and what part is interest.
You can read more about how interest is taxed on our page Tax on savings income.
If you have a pension from overseas, it is important to establish what the UK tax position is in the first instance. If you are resident and domiciled in the UK, the overseas pension is likely to be taxable in the UK, but see our page UK tax on overseas pensions as these can be complicated. This separate guidance also explains how you pay tax on overseas pensions.