Do I Have to Pay Tax on my Personal Pension?
If you’re saving into a personal pension it’s important to have a clear understanding of how your regular contributions and the income you draw once you reach retirement are treated by the UK government for tax purposes.
This article takes a closer look at exactly how the tax treatment of your personal pension contributions will differ depending on your earnings and how income tax is applied to either your drawdown or annuity payments.
Are personal pension contributions tax-deductible?
In essence, yes they are, although not really in the same manner as other deductions which fall under the definition of an allowable expense.
Traditionally, tax-deductible expenditure is subtracted from your total gross annual income, therefore, reducing your overall tax liability. As personal pension plans qualify for tax-relief, this can have the same effect depending on your marginal rate of tax.
Do contributions reduce my tax liability?
If you’re a basic-rate taxpayer (20%), in effect, you won’t see any tangible reduction in your overall tax liability as your personal pension contributions are paid after income tax and national insurance deductions.
In this instance your tax-relief is claimed at source by either your pension provider or employer directly from HMRC and then paid directly into your fund. So, for example, if you pay £80 per month into your pension a further £20 is added each time.
For both higher (40%) and additional-rate (45%) taxpayers, rather than claiming at source, further tax relief is made available by increasing the original income tax thresholds in line with your gross personal pension contribution.
This allows for a higher percentage of your overall income to be taxed at a lower rate, therefore, reducing your overall tax liability by the additional relief you’re entitled to.
So, for example, if you’re a higher rate taxpayer earning £75,000 per year and make personal pension contributions of £25,000, the basic-rate threshold (normally up to £50,000) will increase by this amount. This means you pay 20% income tax rather than 40%.
As a result your overall tax liability would be reduced by £5,000, which in this example equates to the additional tax-relief allowed, based on your income and contributions. The exact same process applies for additional-rate tax relief.
How to claim higher-rate tax back
If you’re a higher or additional rate taxpayer, claiming tax-relief back on your personal pension contributions is done via a self-assessment tax return (for higher rate taxpayers you can also contact your local tax office directly either via phone or in writing).
When submitting your tax return you must include full details of all your personal pension plans and the total gross annual contributions you have made for that particular year (excluding any payments made by an employer).
If you’re unsure of what steps to take or if you’re simply looking for more information about tax treatment of personal pension contributions, a financial advisor can help. They can work with you to claim back your tax relief and much more.
How much tax do I pay on personal pension income?
Once you reach 55 years of age you can, from this point on, begin to take the benefits from your personal pension if you wish.
If you decide to retire, there are two main options available to you for your pension fund:
Regardless of which option you choose, all pension income is classed as earned income for tax purposes. The amount of income tax you will pay is based on your total income (from all sources) and the rate which applies within the particular threshold.
Does my personal tax allowance apply to my pension income?
Yes, it does. For the current tax year (2019/20), the personal tax allowance is £12,500, which means any income you earn up to this amount – whether from a pension or other sources – will incur 0% tax.
Any income over this amount will fall into the next tax threshold and be subject to tax at this rate (20%).
As an example, if your total income in the current tax year is £15,000 – including your personal pension income – the first £12,500 will incur 0% tax and the remaining £2,500 will be subject to a 20% rate. So, the total tax due would be £500.
Is it taxed at source?
Yes, typically, all personal pension income payments are taxed at source. Your pension provider will be able to deduct any tax due, based on your tax code and send this directly to HMRC on your behalf.
What’s the maximum amount of tax-free cash can I take?
When you decide to begin taking your personal pension benefits, at the outset you are allowed to take a maximum of 25% tax-free cash lump sum, based on the value of your fund.
For example, if the total value of your pension fund is £200,000, you are allowed to take £50,000 straight away as a tax-free lump sum and the remaining £150,000 will be used for your retirement income.
The 25% tax-free lump sum is only available from the outset. You cannot defer this decision until a later date.
Will I still be taxed if I’m a non-taxpayer?
No, if you’re a non-taxpayer and your total income is below your personal allowance then your pension income will not be taxed.
The only exception to this is where the 25% tax-free lump sum has been taken and, as a result, an emergency tax code has been applied to your overall income by HMRC as a result.
In these circumstances, you will be able to apply for a tax refund on any emergency tax which may have been deducted from your personal pension income.
Can I use a personal pension tax calculator to work out how much income tax I may have to pay?
Yes, this is possible. Online calculator tools are quite an effective way of giving you an estimate of how much income tax you may incur, based on your total pension income during the year.
It’s important to remember that a calculator will only be able to provide a snapshot of how much tax may be due. It’s always recommended to speak with an experienced advisor who will be able to help you arrange your tax affairs.
This is where a financial advisor can help, like the ones we work with. A financial advisor can talk to you directly about your pension income and accurately assess how much tax may be liable.
Speak to a pensions expert
If you’re paying into a personal pension, it’s important to have a good understanding of the tax rules for both the tax-relief available on your contributions and when the time comes to commence drawing an income from your fund.
The advisors we work with will be able to offer all the expertise you need so you can be clear as to how much tax-relief you will get and what happens when you decide to take your pension benefits.
All advice is free and any information is always given in the strictest confidence. Call us on 0808 189 0463 or make an enquiry to get started.