Table of Contents
Generally, one’s source of income after retirement is a pension. In some cases, your pension is taxable too. It is decided whether you have to pay or are exempted from paying tax on your pension depending on your total annual income.
How to Avoid Paying Tax on Your Pension in UK?
But if your only source of income is the state pension, you are not required to pay any taxes on it. However, if you have other sources other than the pension, you are entitled to pay tax on the amount exceeding the tax threshold.
Income received through a pension is classified as income and hence is taxable. This guide will help you know all the basics of tax liability on your pension and how to avoid paying tax on your pension.
How much tax is to be paid as income tax on your pension?
In a tax year, if your annual threshold is up to £12,500, you can receive a maximum amount of £8,767 as a pension. However, if your total income exceeds the tax threshold, you will incur income tax on the exceeding amount at a certain tax rate.
For instance, if the person’s annual income is £10,000, including a pension of £8,767. Hence, his total income for a tax year is £18,767, while his allowance is £12,500. Therefore, he is entitled to pay an income tax of 20 percent on the amount exceeding the tax threshold, i.e., 20 percent on £6,267. It will result in his net income being £15,514.
If your income exceeds £12,500 but is below £50,000, you are subjected to pay 20 percent on your income above the personal allowance as income tax.
There are still certain other situations in which you do not have to pay any income tax on any amount of pension.
Do you have to pay income tax on your pension even if you are working at present?
Even when you are working and are drawing a pension, you are liable to pay a tax on all your income above the personal allowance, i.e. £12,500. According to your tax band, the income tax is equal to the income tax rate (according to your tax band) on your income above the tax threshold.
Moreover, if your pension has exceeded a specific amount that exceeds the lifetime threshold, you are subjected to additional taxes on your pension amount.
You can work while receiving a state pension or a private pension. However, you cannot work as an employee for the same employer who provides you with the pension.
How to avoid paying tax on your pension?
To avoid paying tax on your pension, you should draw only a necessary amount within a tax year. It means that if you keep your income low, you would have to incur lower income tax.
However, you can take 25 percent of your total pension amount as tax-free. It would not affect your personal allowance. For instance, if your full pension amount is £80,000, you can take out £20,000 of your pension amount tax-free. Tax will be liable to the remaining amount of your pension. In this case, the tax will be charged on the remaining £60,000. The pension provider will automatically deduct the tax before you receive it.
You might as well take all the pension amount without paying any taxes in certain conditions. These conditions include.
- You have an age below 75 years
- Your life expectancy is less than one year. For instance, you have some severe illness.
- Your pension savings is less than a lifetime threshold of £1,073,100
If your age is over 75 years, you would have to incur an income tax on your pension amount.
How much is Pension tax relief?
Pension savings have the benefit of tax relief. The government offers tax relief on pension savings to encourage people to start saving money for retirement. The pension provider can claim the income tax from HMRC that has been paid from your pension amount.
The amount claimed back would be contributed to your pension savings. The tax relief rate is provided below for each income tax rate.
- If income tax is charged at a basic rate of 20 percent on your pension, you will get 20 percent pension tax relief.
- If income tax is charged at a higher rate of 40 percent on your pension, you will get 40 percent pension tax relief.
If you pay income tax at a higher rate or additional rate, you would have to file a tax return to claim the extra tax relief from Her Majesty’s Revenue and Customs (HMRC). It means that 20 percent or 45 percent tax relief (for higher rate and additional rate respectively) will be added, but to claim the remaining 20 percent, you would require to file a tax return.
As per this tax relief, for every £1 you contribute to the pension amount, it will become £1.25, £1.66, £1.80, respectively, according to the income tax rate on your income.
How can you get Pension Tax Relief?
There are two methods of getting Pension Tax Relief in your pension contributions. These include
- Relief at source: Your pension provider deducts tax as usual. Then he can claim back the tax paid, which will be added to your pension savings.
- Net pay: The pension contribution is already deducted from your pension before it is taxed. Hence you would not require to claim any tax relief.
How is the tax paid on your state pension or a private pension?
The income tax is automatically deducted from your pension by the pension provider before it is handed out to you. At the same time, the tax owed on your state pension is also deducted. The amount collected is sent to HMRC (Her Majesty’s Revenue and Customs).
If you receive a pension from more than one pension provider, the tax on your pension will be deducted from only one of the pension providers. You will receive a P60 at the end of a tax year, which informs the amount of tax that has been deducted throughout the year as a tax on your pension.