Pensions in payment are treated as ‘earned income’ for income tax purposes, however you will not pay any National Insurance Contributions on pension income.
If you want to read more on this, The Pensions Advisory Website has a very clear article here.
Typically; your personal pension will be taxed as follows:
1) You can take 25% of your personal pension fund as a cash tax-free lump sum.
You do not have to pay any income tax on the cash lump sum, as long as you do not take more than a quarter (25%) of your pension fund as cash.
You can take your tax-free lump sum in one go, or in stages.
The proportion of tax-free cash may be higher if you have a protected lump sum which were available on some older pension plans. If you think you may have an older pension, it is worth checking this with your Provider, or asking your Independent Financial Adviser (IFA) for advice on this.
2) The remaining 75% balance of the pension fund will be taxed as earned income.
The amount of income tax that you pay on your pension income depends on your gross taxable income in any tax year. Your income may come from various sources in retirement (possibly from State Pension, Personal Pensions, Final Salary Pensions, Investment Income, Rental Property Income etc.) so this is all added together.
Everyone has a Personal Allowance (which is currently £12,500 for the 2019/20 tax year, however your Personal Allowance reduces if your total income exceeds £100,000).
You do not pay any income tax if your gross income from all sources does not exceed your personal allowance in any tax year.
If your total income exceeds the personal allowance you will pay income tax at either 20% within the basic rate band, 40% within the higher rate band in or 45% within the additional rate band. There is further information on income tax rates on The Pension Advisory Service website here.
3) How your pension provider calculates what rate of income tax to deduct from your pension income
Your pension provider will deduct income tax before paying the balance to you by using your PAYE tax code and paying the tax to HMRC on your behalf.
If you receive your pension income from more than one source; i.e. the State Pension and Personal Pensions, each Provider is given a tax code by HMRC to allow them to calculate the correct amount of income tax to deduct (whether this is 20%, 40% or 45%) from the pension income they pay you.
4) Checking your tax code is correct and not too much, or too little tax is deducted
You should check the tax code(s) that have been given to each Provider to make sure that the correct amount of income tax has been deducted. There is a great calculator on the MoneySavingExpert.com to help you calculate your correct tax code here.
If you do overpay tax, you can claim this back at the end of the tax year by contacting HMRC.
How do I get independent pension advice on pensions and retirement planning?
Tax and pensions can seem a complex area; we are always very happy to arrange an initial meeting, at no cost to you, to provide you with detailed advice on the area, particular to your circumstances and future retirement goals.
Please contact us at info@martin-redmanpartners.co.uk or call us on 01223 792 196 to arrange an initial appointment with one of our Independent Financial Advisers.
About Martin-Redman Partners
We are a team of experienced Independent Financial Advisers (IFAs) who can advise on your personal or business financial arrangements. We have been building trusted relationships with clients for many years by articulating clear and tailored recommendations in areas ranging from investments to retirement planning, to complex estate planning advice.
We offer expert independent financial advice throughout Cambridgeshire, Leicestershire, Suffolk, East Anglia and the South East. Many of our clients are within, or are in the surrounding areas of Cambridge, Grantham, Stamford, Bury St Edmunds, Frinton on Sea, Ely, Peterborough, Huntingdon, Cambourne, Newmarket, Soham and Oundle.
The information contained is for guidance only and does not constitute financial advice. It is based on our understanding of UK legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change. Accordingly, no responsibility can be assumed by Martin-Redman Partners its officers or employees, for any loss in connection with the content hereof and any such action or inaction.