When you retire, your life goes through a lot of significant changes. It changes your daily routine, your income as well as the tax you pay on your pension at the end of each fiscal year. In this article, we discuss how pension income is taxed in the UK and other essential concepts you must be aware of in regards to taxation on your pension income.
National Insurance Contributions And Income Tax
If you have been wondering, yes, you still need to pay your taxes even after you have retired. Taxes apply to your complete pension income which also includes your state pension. It is assumed by a lot of people that their pension income, particularly their state pension, will not be taxed. However, that is not how it works. Some income (inclusive of your state pension) is paid without the exclusion of any tax. That said, if any tax is due, that money will be collected by way of taking money off the pension payments of any company or from the money you take from a personal pension or a workplace.
Income Tax Personal Allowances
It is possible for you to receive or earn up to a total of £12,500 in the taxation year of 2019-2020 (from April 6th to April 5th) without paying any taxes on it. This is known as your personal allowance. This means that if you receive or earn less than this amount, you are not a taxpayer.
How Is Your Pension Income Taxed?
Typically, you can withdraw 25% or less of your tax-free pension pot. The rest of the pension pot can either be withdrawn or used to offer an income. In any case, it will be taxable. This means that any money you get over your personal allowance shall be taxed.
What Is Defined Benefit Pension?
In case you possess a career average pension, a final salary or a defined benefit pension, you can typically take 25% or less of your pension without paying any taxes on it. However, you will get the rest in the form of income, and this will be taxable.
What Is Defined Contribution Pension?
According to the changed rules from April 2015, you can take money from your pension according to your will. That said, only the initial 25% of the total pension amount will be exempt from taxes. You will have to pay tax on the rest. The total tax rate that you pay will increase if your income crosses certain thresholds. In other words, the more money you withdraw from the pension pot, the more will be your tax bill.
Income From Multiple Sources
As you work and work for a number of years, multiple sources of income become quite common. For instance, you might work part-time and also have income coming in from your workplace pension in addition to some savings you have. Therefore, if you have multiple sources of income, you must inform HMRC so that you do not end up paying the wrong amount of taxes against all the incomes. Remember that your personal allowance will be allocated against your pension or main job.
In case this is the situation, any other income received by you shall be taxed at 20%, 40% or 45% according to the tax band your incomes fall into. Also, your PAYE code will show letters against it that will let you know precisely how much tax you can expect to be deducted each taxation year from each of your income sources. That said, if your income from different sources falls less than the personal allowance of £12,500 for the fiscal year 2019-2020, you must request HMRC to spread the personal allowance between your different income sources to ensure that you do not end up paying a mountain of tax. Still, if you do end up overpaying tax, you can claim it at the end of the year.
Savings Tax-Free Interest
The personal savings allowance that was introduced in 2016 is essentially the total amount of savings income which you can receive free of tax. For the current fiscal year, it is £1,000 for all basic rate taxpayers as well as £500 for all higher rate taxpayers. In addition to that, the previous option of the R85 form to get interest without having to pay tax is no longer an option.
In the same vein, since April 2016, building societies and banks do not deduct the basic rate tax any longer from the interest calculated on your savings. Rather, if your savings income falls over £1,000 or £500 for a basic rate taxpayer and a higher rate taxpayer respectively, HMRC shall collect all taxes that are due via your PAYE code. Also note that if you typically declare your savings income via a self-assessment tax return, you must continue to do so.