Figures reported by FTAdviser have revealed that the number of pensioners paying Income Tax has surged in recent months.
The findings released on 29 June 2023 showed that 8.5 million pensioners were paying Income Tax in the 2023/24 tax year, compared to 7.73 million in 2022/23 – an increase of around 10%.
When you begin taking an income from your pension, it’s important to ensure you don’t overpay tax. But the rules surrounding taxation on retirement income can be complex. Below are five important tax rules to be aware of to help you avoid overpaying tax in retirement.
1. You can access 25% of your pension pot tax-free
You can usually withdraw the first 25% of your pension savings tax-free, either as a one-off lump sum or spread across a number of smaller withdrawals. This is known as the “pension commencement lump sum” (PCLS).
If you choose to take your pension in several small lump sums, then 25% of each withdrawal will be tax-free, and the remaining 75% of the withdrawal will be subject to Income Tax at your marginal rate.
There is an important caveat to this tax rule though: the maximum PCLS that you can take tax-free in 2023/24 is £268,275. This is 25% of the Lifetime Allowance (LTA), which is £1,073,100.
The LTA tax charge has been removed for the 2023/24 tax year (with a view to abolishing the LTA in 2024), but if your pension pot exceeds this amount, your PCLS will be capped unless you have taken out LTA protection.
2. Large pension withdrawals could push you into a higher tax band
Pension withdrawals above the PCLS and in excess of your Personal Allowance for the tax year are subject to Income Tax at your marginal rate. Your pension withdrawals are added to any other types of income, including your State Pension and any earnings you have.
So, if you withdraw a large lump sum from your pension, it could push you into a higher Income Tax band. As such, it’s possible that you may pay a higher rate of tax than you are used to.
It’s important to keep a close eye on how much income you are likely to receive to avoid overpaying tax. For example, if a large pension withdrawal could push you into a higher tax band for this tax year, you might consider delaying the withdrawal until the next tax year.
Your financial planner can help you to decide the most appropriate course of action for your circumstances.
3. Continuing to contribute to your pension could trigger the Money Purchase Annual Allowance
If you decide to contribute more money into your pension after you have started to draw a flexible income, you could trigger the Money Purchase Annual Allowance (MPAA). This limits the amount you can contribute and still receive tax relief on to £10,000 each tax year.
This might be particularly important if you decide to take a phased retirement, or return to work after retiring and you continue to contribute to your pension from your earnings.
If you trigger the MPAA and subsequently exceed this threshold in contributions, you could face an additional tax charge. So, keep a close watch on your pension contributions if you are in this position.
4. Your provider may deduct emergency tax from your first pension withdrawal
If your pension provider doesn’t have an up-to-date tax code for you, it’s likely that your first pension withdrawal will be taxed on an emergency rate. The emergency rate is usually higher than the normal tax code – this is because HMRC assume you will be drawing the same amount every month – and as such, you may end up paying more Income Tax on this withdrawal than needed.
If this happens, you can claim back the additional Income Tax you paid by completing a form on the government website and submitting it to HMRC. There are different forms to use depending on whether you have taken a one-off lump sum from your pension or if you are taking a flexible income from the pot.
5. You could overpay tax if you have income from multiple sources
When you first enter retirement, it’s possible that you might be taking income from multiple sources, such as:
- Savings
- Investments
- State Pension
- Workplace or employer pensions
- Private pensions
- Part-time earnings
- Self-employed earnings.
If this is the case, it’s important to make HMRC aware of your different income streams so that they can apply the correct tax code.
By distributing your Personal Allowance across your various streams of income, you can ensure that you pay the correct rate of tax on all the different parts of your income.
You can use the government website to check and update your tax code for the year. You can also claim a tax refund if you find that you have overpaid tax.
Get in touch
The rules surrounding taxation of pension and retirement income can be complex. If you’d like help understanding your personal tax position and how to improve it, we can help.
Please get in touch by emailing us at financial@barwells-wealth.co.uk or by phone on 01273 086 311.
Please note
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.
The Financial Conduct Authority does not regulate tax planning.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
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