What tax do I pay on my state pension lump sum?
Normally you receive your state pension as a regular payment. You usually receive a payment every four weeks. This page explains what tax is applied to 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.
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’, such as the marriage allowance and the married couple’s allowance. Please see the page What tax allowances and I entitled to? for more information.
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.
When is a state pension lump sum taxed?
The state pension lump sum is taxed in the year in which you stop deferring and decide to claim it. It does not matter when the lump sum is actually paid (although, in practice, it will usually be in the same tax year). But you can opt 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.
For example, Matthew reached state pension age in February 2015 but continued working up until February 2018. He chose to defer claiming his state pension until he stopped work. From 6 April 2017 to his retirement in February 2018, he earned £18,000 so he was a basic rate taxpayer in 2017/18. In 2018/19, however, his only income will be his state pension of £170 a week (£8,840 for the year). His 2018/19 income is therefore well below his personal allowance of £11,850, meaning he is a non-taxpayer.
Matthew starts taking his weekly pension from March 2018, but asks The Pension Service to defer payment of his state pension lump sum until the start of the 2018/19 tax year. They pay the lump sum in April 2018. Matthew pays no tax on the lump sum, as he is a non-taxpayer in 2018/19. (If he had taken the lump sum in March 2018 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.)
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. 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.
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.
Luke, a basic rate taxpayer
Luke, who lives in England, is entitled to a state pension lump sum of £15,000 in tax year 2018/19. His other income for 2018/19 consists of earnings of £26,730 and state pension of £6,440. For the tax year 2018/19 he is entitled to a personal allowance of £11,850. The upper limit at which you are taxed at basic rate is £34,500.
First, we need to work out what Luke's taxable income is for tax year 2018/19:
State pension £6,440
Less personal allowance (£11,850)
Total income less allowances £21,320
Next, we work out what Luke’s highest rate of income tax is for 2018/19. As Luke's taxable income of £21,320 is not more than the basic rate limit of £34,500, 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 £15,000 x 20% = £3,000.
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, who is not a Scottish taxpayer, is entitled to a state pension lump sum of £7,500 in 2018/19. His other income for 2018/19 is earnings of £5,500, state pension of £5,000 and savings interest of £3,000.
So, his taxable income for 2018/19 is:
State pension £5,000
Savings interest £3,000
Less personal allowance (£11,850)
Total income less allowances £1,650
Next, we determine the highest rate of tax payable by Graeme, ignoring special rates for savings income. Graeme’s taxable income of £1,650 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 £7,500 x 20% = £1,500.
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. Part of his savings interest falls within his personal allowance and the rest is taxable at the starting rate for savings.
Debbie – example of taxpayer with dividend income
Debbie, who is not a Scottish taxpayer, is entitled to a state pension lump sum of £10,500 in 2018/19. Her other income for 2018/19 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 for 2018/19 is:
State pension £2,500
Savings interest £6,000
Dividend income £1,900
Less personal allowance (£11,850)
Total income less allowances £7,050
Next, we determine the highest rate of tax payable by Debbie, ignoring special rates for savings income and dividends. Debbie’s taxable income of £7,050 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 £10,500 x 20% = £2,100.
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 £11,850. Her savings interest falls within the remainder of her personal allowance, the £5,000 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 2018/19 and earns £10,500. 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 £12,137. This is above her personal allowance of £11,850 so she is a basic rate taxpayer for the year. She decides to defer receiving her state pension lump sum until 2019/20. Her other income for that year is expected to be her state pension only and she will therefore not pay tax for 2019/20. On that basis her state pension lump sum will not be liable to tax in 2019/20 whereas it would have been liable to basic rate tax (20%) in 2018/19.
If Jane did not defer her state pension lump sum, but received it in 2018/19, because her total income is £12,137, she would be liable to basic rate tax (20%) on the lump sum.
It is important to note that if Jane’s husband elected to transfer part of his personal allowance to her for 2018/19, the marriage allowance, this would not change the fact that for these purposes Jane would still be treated as a basic rate taxpayer and the state pension lump sum she received would still be liable to tax at the basic rate. This is because deductions such as the marriage allowance or married couple’s allowance are not taken into account in determining the rate of tax to be applied to a state pension lump sum.
Her total income is £12,137, taking her into the basic rate band. The marriage allowance means that her husband transfers £1,190 of personal allowance to her. But this does not reduce her taxable income – instead it reduces her tax liability by £238 (£1,190 at 20%). It cannot produce a tax repayment though.
Her 2018/19 tax liability on her employment and state pension income is therefore £287 (£12,137 - £11,850) at 20% = £57. The marriage allowance reduces this to nil. Nevertheless, she must pay basic rate tax on her state pension lump sum, but this liability can be reduced by the remainder of the marriage allowance of £181 (£238 - £57).
Where can I find more information?
For more information on deferring the state pension, visit our section 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.