Saving into a pension is a fantastic way to boost your long term wealth. You\u2019ll receive pension tax relief on payments into your pension and you won\u2019t pay tax on any income earned within your pension pot. When it comes to drawing your pension you can also take the first 25% tax free.<\/p>
In this guide we explain everything you need to know about pension tax. We also answer common questions like \u201cdo I have to pay income tax on my pension?\u201d and \u201chow do I calculate tax on my pension?\u201d<\/p>
When you start drawing your pension<\/a>, you\u2019ll be able to take the first 25% tax free. The remaining 75% is taxed just like other income. You\u2019ll have to pay income tax but national insurance isn\u2019t due on pension income.<\/p> Because tax is calculated annually, it\u2019s important to think about how taking your pension will affect your tax bill. For example, it\u2019s possible that taking a large amount of your pension in one go will push you into paying higher rate tax for that year.<\/p> Your pension is taxed because it is classed as a type of income. This means your pension will be added to other types of income to work out your total taxable income.<\/p> You\u2019ll pay income tax of 20% on all your income once you earn more than your personal allowance of \u00a312,570 per tax year. Higher earners will pay income tax of 40% on earnings between \u00a350,270 to \u00a3125,140.<\/p> The income tax rates on pension income are the same as other types of income.<\/p> Brits living in England, Wales and Northern Ireland currently have a tax-free personal allowance of \u00a312,570. Amounts earned between \u00a312,570 and \u00a350,270 are taxed at 20%, while income between \u00a350,271 and \u00a3125,140 is taxed at 40% and 45% for income over \u00a3125,140.<\/p> Tax rates in Scotland are slightly different. There are more tax bands and a higher tax rate of 42% is charged on earnings from \u00a343,663 to \u00a375,000.<\/p> You can\u2019t completely avoid paying tax on your pension but you may be able to minimise the amount of tax due. Here are some tips that may reduce your income tax bill<\/p> You can withdraw 25% of the value of your pension scheme completely tax free (capped at \u00a3268,275). After this, the remaining 75% will be taxed with income tax when you draw it, just like any other earned income.<\/p> State pension<\/a>, any earnings and income from private pensions<\/a> are all part of your annual taxable income. That means you\u2019ll pay tax on state pensions if your total income is over your personal tax free allowance of \u00a312,570.<\/p> Your pension provider will collect any tax you owe on your private and state pension before transferring your pension income. At the end of the tax year you\u2019ll receive a P60 from your pension provider showing what tax you\u2019ve paid.<\/p> Income from annuities is taxed with income tax but not national insurance. Annuity income will be added to any state pension and other income to work out your total taxable income.<\/p> Emergency tax is charged when the inland revenue doesn\u2019t know what your tax code should be. This sometimes happens when you start receiving a new income stream like a pension.<\/p> It can mean that you pay too much tax for a while because the emergency tax code is based on you having this new income for the whole tax year.<\/p> You will be able to claim back any tax you have overpaid at the end of the tax year.<\/p> Your pension annual allowance is sometimes called a money purchase annual allowance. It\u2019s the amount you\u2019re allowed to contribute into your pension each year. Most people have an annual allowance of \u00a360,000 per year. The limit was introduced to stop higher earners getting a huge amount of tax relief on their pension contributions.<\/p> Your pension annual allowance may be reduced to \u00a310,000 if you\u2019ve started drawing money out of your pension.<\/p> If you\u2019re still working then all your income will be added together from your work and pension to work out your total taxable income for the tax year.<\/p> If you have a very large pension pot, you may have additional tax charges on top of income tax.<\/p> Tax relief on pension contributions depends on how your workplace scheme is set up.<\/p> There are two different methods of setting up tax relief for employees, gross tax basis and net tax basis. Schemes using the gross tax basis take your pension contributions before any tax is taken from your pay. The net tax basis takes your pension contributions from your net pay, after you\u2019ve paid tax. Tax relief of 20% is claimed and added to the pension scheme at a later stage.<\/p> If you\u2019re a higher rate taxpayer and your employer uses the net tax basis then you\u2019ll need to claim the extra 20% tax relief using your tax return. That\u2019s because you are due 40% tax relief on your pension but will only get 20% automatically.<\/p> Ask your employer which tax relief method if your pension contributions are taken before or after tax has been paid.<\/p> The auto enrolment rules mean that more employers than ever have a workplace pension scheme for their employees. As part of their responsibilities, employers need to make sure the right tax relief is applied to employee pension contributions.<\/p> If you\u2019re an employer then you need to decide whether to set up your workplace scheme on a gross or net tax basis. A gross tax basis means that employees will pay pension contributions before they pay tax. A net tax basis means that employees will pay contributions after they pay tax. If you choose the net method, you will need to claim tax relief for your employees at the end of the year.<\/p> It\u2019s a good idea for employers to check with their accountant that they have set up tax relief correctly. The rules are complicated and you may get a fine if you haven\u2019t set up your scheme properly. Employers need to make sure that they\u2019ve applied the same tax relief settings (gross or net method) to their payroll and pension scheme.<\/p> Most employees in England, Wales and Northern Ireland will get 20% tax relief on their pension contributions, but it will depend on their circumstances. Employees\u2019 contributions are capped at a maximum annual allowance of \u00a360,000 per year. Older employees who have already taken money out of their pension may have a lower limit of \u00a310,000.<\/p> Higher rate taxpayers may receive more than 20% tax relief on their pension payments. If your pension scheme is set up on a gross basis then they will get 40% tax relief automatically. If you have a net basis scheme then they will need to claim back 20% tax on their tax return.<\/p> Tax relief for Scottish employees is slightly different as there are more tax bands and higher earners pay 42% or above on earnings starting from \u00a343,663.<\/p>Why is my pension taxed?<\/h3>
What tax rate applies?<\/h3>
How can I avoid paying tax on my pension?<\/h3>
How much tax do I pay on a pension lump sum?<\/h3>
Do I pay tax on state pensions?<\/h3>
How do I pay tax on my private pensions?<\/h3>
What about tax on annuities?<\/h3>
What is emergency tax?<\/h3>
Pension annual allowance<\/h3>
How much tax will I pay on my pension if I am still working?<\/h3>
Is there any other pension tax I should know about?<\/h3>
How pension tax relief works for employees<\/h3>
How do I check which pension tax relief method I\u2019m on?<\/h3>
What employers need to know about auto enrolment tax relief<\/h3>
How to set up pension tax relief correctly<\/h3>
How much pension tax relief will your employees get?<\/h3>