What tax do I pay on my state pension lump sum?

Updated on 20 April 2019

Pensioners

Normally you receive your state pension as a regular payment. You usually receive a payment every four weeks. You can read about when these regular payments are taxable on our page What is income?. This page explains what tax is applied to a state pension lump sum.

When might I receive a state pension lump sum?

If you reached state pension age before 6 April 2016 and deferred receiving your state pension for at least 12 months in a row, you can choose to receive a one-off lump sum – in addition to your regular state pension – when you later decide to draw your state pension. This is taxed as income, but in a special way, unlike other pension income.

Alternatively, you may receive a state pension lump sum because your spouse or civil partner chose to defer their state pension but died before any lump sum was paid.

If you reached state pension age on or after 6 April 2016, you may still defer receiving your state pension, but you will not be entitled to receive a lump sum.

You can find out when you are due to reach state pension age using the calculator on the GOV.UK website.

What tax do I pay on my state pension lump sum?

Put simply, the rate of tax that will be used on your state pension lump sum is generally the highest rate that applies to your other income for that tax year.

All else being equal, this is intended to avoid the lump sum (or part of it) being taxed at a higher rate than you would have paid had you not deferred it. However, the rules may not necessarily give that result.

It is important to bear in mind that when you are looking at your ‘other income’ you must ignore the 0% rates which are used to tax savings and dividend income, i.e. the starting rate for savings, the savings nil rate (or personal savings allowance) and the dividend nil rate (or dividend allowance). In other words, the question is what is the highest rate of tax which would apply if income falling in these 0% rates were taxed at the normal rates. This can make a significant difference to the tax payable on the lump sum. See below for some examples.

For this purpose, because we are looking at the tax rate applicable, we ignore any allowances and reliefs which are in fact ‘tax reducers’ in the tax calculation, such as the marriage allowance (as it applies to member of the couple receiving it) and the married couple’s allowance. Please see the page What tax allowances and I entitled to? for more information, but see also the ‘word of warning’ note below relating to the marriage allowance.

If you live in Scotland and are a Scottish taxpayer, different income tax rates and bands apply to your non-savings and non-dividend income. There is more information in our section on Scottish income tax.

The Pensions Service deducts tax from the lump sum on making the payment, having taken account of information that you provide as to your rate of tax. As the calculation is made during the tax year, it will not always be correct. If the wrong tax rate is used an overpayment of tax may arise or you may have to pay more tax to make up the difference. HM Revenue & Customs (HMRC) will make the adjustment after the year end.

If you live in Scotland and are a Scottish taxpayer, The Pensions Service deducts tax at either 20% or 40%, rather than the Scottish rate at which you are liable. It is particularly important that you check what tax has been deducted and how much you should have paid.

Word of warning – marriage allowance

The marriage allowance, or transferable tax allowance, works in a strange way. The member of the couple that gives up 10% of their personal allowance to their partner has a reduced personal allowance. But the partner receiving the allowance does not get a higher personal allowance, they instead get a tax credit.

Example

Let’s say that Janet elects to transfer 10% of her tax allowance to her husband Bill in 2019/20.

Her reduced personal allowance for 2019/20 is £12,500 - £1,250 = £11,250.

If she then claims a state pension lump sum in 2019/20, she will be a taxpayer if her other taxable income is more than £11,250. Tax on the lump sum would then be due.

However, Bill’s personal allowance for 2019/20 will stay at £12,500. The 10% that Janet has transferred to him is not added to this figure. Instead, it gives him a tax credit of £250 (£1,250 x 20%) to take off his tax bill.

So if Bill takes a state pension lump sum in 2019/20 and his other taxable income is more than £12,500, tax will be due on the state pension lump sum. The tax due on the state pension lump sum cannot therefore be reduced by the marriage allowance.

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When is a state pension lump sum taxed?

The state pension lump sum is usually taxed in the year in which you stop deferring and decide to claim it. The point at which the lump sum is taxable is the tax year in which the first benefit payment date falls. This will usually be the same tax year in which you notify the DWP’s Pension Service of your claim to the state pension. However, if you claim very close to the tax year end, it could be the next tax year.

For example, Richard decides to stop deferring his state pension at the end of the 2018/19 tax year and notifies the Pension Service of his claim to the state pension on 3 April 2019. He tells them that he wants to claim a lump sum for the period in which he has been deferring his claim. He is informed that the first weekly entitlement date for his state pension will be 9 April 2019. This means that his lump sum will be taxable in 2019/20 unless he claims to delay receipt of it until April 2020, in which case it will be taxable in 2020/21 (see below). So even though Richard claimed his state pension in 2018/19, the default tax point for the lump sum is in 2019/20.

Claiming to delay receipt of a state pension lump sum to the start of the next tax year

You can choose to delay payment of the lump sum to the next tax year to the one in which you stop deferring, which means that it will then be taxed in that later year. You might choose to do that if, for example, you are a basic rate (20%) taxpayer in the year you stop deferring, but will be a non-taxpayer the following year.

Note: if you wish to delay receiving a state pension lump sum to the start of the next tax year, you need to tell the Pension Service when you claim the lump sum, or within a month of the date you make the claim.

“The state pension lump sum is taxable in the year in which the person is entitled to it, that is, when the lump sum option is chosen on ceasing to defer. This is irrespective of when it is actually paid. If, say, a person stopped deferring and chose a lump sum on 1 April but that lump sum was not in fact paid until early in the new tax year, the tax point nevertheless would be 1 April.

This is unless a ‘tax election’ is made at the same time as choosing the lump sum (at the time of claiming the deferred state pension), or within a month of that day (Reg 21A(3) SI 1987/1968). This election allows the pensioner to opt for the lump sum to be paid early in the next tax year and also to be taxed in that later year.”

For example, Matthew reached state pension age in February 2015 but continued working up until February 2019. He chose to defer claiming his state pension until he stopped work. From 6 April 2018 to his retirement in February 2019, he earned £18,000 so he was a basic rate taxpayer in 2018/19. In 2019/20, however, his only income will be his state pension of £170 a week (£8,840 for the year). His 2019/20 income is therefore well below his personal allowance of £12,500, meaning he is a non-taxpayer.

Matthew starts taking his weekly pension from March 2019, but asks The Pension Service to defer payment of his state pension lump sum until the start of the 2019/20 tax year. They pay the lump sum in April 2019. Matthew pays no tax on the lump sum, as he is a non-taxpayer in 2019/20. (If he had taken the lump sum in March 2019 when he stopped deferring, he would have paid 20% tax on the lump sum, so would have ‘lost’ £20 in tax for every £100 of lump sum.)

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What if I die before I receive my state pension lump sum?

If you are married or in a civil partnership, the lump sum will be paid to your surviving spouse or civil partner as noted in the section below. Otherwise the lump sum will be paid to your estate if you had claimed it before you died, but it had not yet been paid (if you had not claimed it, any accrued lump sum is lost and only three months of State Pension can be claimed). Normally the lump sum would become payable and be liable to income tax in the tax year of your death.

If you had made an election to receive the lump sum in a later tax year, it will remain payable and liable to income tax in the tax year of your death if you were to die before the start of that later year. On the other hand, if you die in the later tax year, having made this election, the lump sum will be taxable in the tax year of your death. In other words, in either of these scenarios the lump sum remains liable to income tax in the tax year of your death.

Where you die within the period when you might have elected to receive the lump sum in a later tax year, but had not made any such election, it is possible for your executors or personal representatives to make that election on your behalf so that the lump sum is payable and liable to tax in the later tax year, provided that you survived until at least 6 April in the later tax year.

If the lump sum is payable to your estate, it will form part of your estate for inheritance tax purposes.

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What tax do I pay on my late spouse’s (or civil partner’s) state pension lump sum?

The tax is calculated as shown above and is payable by you for the tax year when the lump sum payment is due to be paid. The due date for payment of that lump sum depends on whether you are already receiving your state pension when your spouse or civil partner dies.

If you are already receiving your state pension, the lump sum becomes payable and is taxable on the date of your spouse’s or civil partner’s death. On the other hand, if you are not yet receiving a state pension at that time, the lump sum becomes payable and taxable at the time you become entitled to your state pension.

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Examples

Luke, a basic rate taxpayer

Luke, who lives in England, claims a state pension lump sum of £25,000 in tax year 2019/20. His other income for 2019/20 consists of earnings of £26,730 and state pension of £6,440. For the tax year 2019/20 he is entitled to a personal allowance of £12,500. The upper limit at which you are taxed at basic rate in 2019/20 is £37,500.

First, we need to work out what Luke's taxable income (leaving out the state pension lump sum) is for tax year 2019/20:

Earnings £26,730
State pension £6,440
Less personal allowance (£12,500)
Total income less allowances £20,670

Next, we work out what Luke’s highest rate of income tax is for 2019/20. As Luke's taxable income of £20,670 is not more than the basic rate limit of £37,500, this is taxed at the basic rate of 20%.

Luke's state pension lump sum is taxed at his highest rate of tax, which is 20%. The tax on his lump sum is therefore £25,000 x 20% = £5,000.

When he applies for a state pension lump sum, the Department for Work and Pensions (DWP) (that is, The Pensions Service) ask Luke to advise them of his expected highest rate of income tax. Assuming he declares the basic rate, then The Pensions Service will take off tax of 20% from the lump sum at the time they pay it to him.

Graeme – example of taxpayer with savings income

Graeme, who is not a Scottish taxpayer, is entitled to a state pension lump sum of £27,500 in 2019/20. His other income for 2019/20 is earnings of £5,500, state pension of £5,000 and savings interest of £3,000.

So, his taxable income (excluding the state pension lump sum) for 2019/20 is:

Earnings £5,500
State pension £5,000
Savings interest £3,000
Less personal allowance (£12,500)
Total income less allowances £1,000

Next, we determine the highest rate of tax payable by Graeme, ignoring special rates for savings income. Graeme’s taxable income of £1,000 falls entirely within the basic rate band of tax.

Graeme’s state pension lump sum is taxed at his highest rate of tax, which is 20%. The tax on his lump sum is therefore £27,500 x 20% = £5,500.

This is despite the fact that Graeme does not actually have a tax liability on his income – his earnings and state pension fall within his personal allowance. The part of his savings interest that is not covered by the personal allowance falls within his personal savings allowance and is therefore taxable at 0%.

Debbie – example of taxpayer with dividend income

Debbie, who is not a Scottish taxpayer, is entitled to a state pension lump sum of £20,500 in 2019/20. Her other income for 2019/20 is earnings of £8,500, state pension of £2,500, savings interest of £6,000 and dividend income of £1,900.

So, her taxable income (excluding the state pension sum lump for 2019/20 is:

Earnings £8,500
State pension £2,500
Savings interest £6,000
Dividend income £1,900
Less personal allowance (£12,500)
Total income less allowances £6,400

Next, we determine the highest rate of tax payable by Debbie, ignoring special rates for savings income and dividends. Debbie’s taxable income of £6,000 falls entirely within the basic rate band of tax.

Debbie’s state pension lump sum is taxed at her highest rate of tax, which is 20%. The tax on her lump sum is therefore £20,500 x 20% = £4,100.

This is despite the fact that Debbie does not actually have a tax liability on her income – her earnings and state pension fall within her personal allowance of £12,500. Her savings interest falls within the remainder of her personal allowance, the £5,000 0% starting rate for savings band (within the basic rate band) and the personal savings allowance. Her dividend income falls within her dividend allowance of £2,000.

Jane, a basic rate taxpayer who opts to receive her lump sum in a later tax year

Jane is employed for the first part of 2019/20 and earns £11,500. She then receives a state pension of £125.95 for the last 13 weeks of the tax year (£1,637). Her total income for the tax year is £13,137. This is above her personal allowance of £12,500 so she is a basic rate taxpayer for the year. She decides to defer receiving her state pension lump sum until 2020/21. Her other income for that year is expected to be her state pension only and she will therefore not pay tax for 2020/21. On that basis her state pension lump sum will not be liable to tax in 2020/21 whereas it would have been liable to basic rate tax (20%) in 2019/20.

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Where can I find more information?

For more information on deferring the state pension, see What is state pension deferral?.

The DWP has published a guide on deferring your state pension, which includes information on state pension lump sums. You can find this guide on the GOV.UK website.

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