As you begin to consider entering retirement and cashing out your pension, you may have questions on what happens next. Additionally, with the self-assessment tax return deadline less than a month away, you may wonder if this is something you are required to do before the 31st of January.
Are Pensions Taxed?
In short, yes. Pensions are classed as a source of income, therefore the majority of pensions are subject to income tax contributions, and are taxed like any other source of income. The current income tax rates for the 2021-22 tax year are:
Up to £12,570
£12,571 to £50,270
|£50,271 to £150,000||40%|
Why are Pensions Taxed?
As opposed to withdrawing the entirety of your contributions in a lump sum, the money is instead being held as part of the pension scheme you were enrolled onto and when withdrawn, the money distributed is treated in the same manner as any other income. As stated above, however, you are only subject to pay income tax when your earnings exceed £12,570 per annum.
There are circumstances, however, where pensions are tax-free. For example, you can usually take out a lump sum of up to 25% of the amount built up in any pension. This tax-free lump sum will not affect your personal allowance. You can also usually withdraw any pension worth up to £10,000 in one go. This is called a ‘small pot’ lump sum and if chosen, this option will mean 25% is tax-free.
How is the Tax Paid?
If you receive both a private pension and the state pension, your provider will deduct any owed tax before you are paid. If you receive payments from two or more providers, HMRC will ask one of your providers to take off any tax that you owe. You will then receive a P60 at the end of the tax year which displays how much tax you have paid for the previous year.
If the state pension is your only source of income when retired, you are responsible for paying any tax that you may owe by completing an annual self-assessment tax return.
If you continue to work while claiming your pension, your employer will deduct any owed tax from both your earnings and State pension. If you are self-employed, you must submit a self-assessment tax return declaring overall income, state pension and any earnings from private pensions.
You must also submit a self-assessment tax return for any income other than the pensions you receive.
Self-assessment tax returns can be submitted without any guidance, however, our experienced specialists can help to provide advice, and ensure that your tax return is submitted correctly and fully compliant the first time around. If you would like help and guidance from one of our friendly accountants or have any other queries related to tax and your pension, please get in contact today.