How is pension taxed, and by who?

agent69

Looking to retire a bit early at the end of March (at 62 & 6 months). I understand that pension income is liable for tax, but I will have multiple income streams and don't understand how this will be taxed and by whom. There are 3 scenarios:

1. Next 2.5 years - take £16k drawdown a year from my DC pension pot. Top this up with ISA / bank account money, possibly an odd bit of freelance work (say £5-10k a year).
2. 65 to 66 - £13k a year from DB pension, topped up by DC drawdown and / or ISA. No work
3. After 66 - government pension + DB pension topped up by DC drawdown and / or ISA

In scenario 1 I may not have any taxable income, so will the drawdown company deduct any tax. If I do some part time work how will the agency tax me?


In scenarios 2 and 3 I will definitely have taxable income, but there are potentially 3 pensions and each of the 3 sources don't know about the other 2. I know the state pension comes un-taxed, but what happens with money from the DB & DC pots?

Dazed_and_confused

HMRC will try and issue appropriate tax codes to each employer/pension company.

In the type of circumstances you describe you can expect to either under or overpay tax, initially at least.

You can help keep on top of things by keeping your income details upto date (after payments have started to be made by the respective employer/pension company) through your personal tax account on gov.uk

dunstonh

Normally, the highest one will get the tax code and the others will pay basic rate on the lot. Or no tax on the others with it taken into account on the main one through the tax code.

drumtochty

[FONT=&quot]You are a bit confused here.[/FONT]
[FONT=&quot] [/FONT]
[FONT=&quot]Scenario 1) You will have taxable income if you are not including tax free commencement lump sums in the drawdown sums advised, you will have no earned income in 1) if you do not do any self-employed temporary agency work. [/FONT]
[FONT=&quot] [/FONT]
[FONT=&quot]As your drawdown income that year is above your taxable personal allowance if no tax free monies included, the drawdown company will tax you on a month1 basis where you are allowed 1/12th of the personal allowance per month before they tax you. HMRC will then advise them of your actual tax code after a month or so. [/FONT]
[FONT=&quot] [/FONT]
[FONT=&quot]If your agency earnings will probably be smallish in most circumstances HMRC will advise the agency to tax you at 20% on all your earnings.[/FONT]
[FONT=&quot] [/FONT]
[FONT=&quot]Let's get one thing straight, neither of these companies will pay you a penny without an NI number and HMRC will be advised by them of all payments and the fact that you are "working" for them, therefore you have to keep accurate records for taxation purposes but HMRC will know what you get from them.[/FONT]
[FONT=&quot] [/FONT]
[FONT=&quot]Any agency payments of more than £702.01 in any month will also deduct national insurance for that month which is not averaged over the year, NI is not a "fair tax".[/FONT]
[FONT=&quot] [/FONT]
[FONT=&quot]Scenario 2) You have stopped working according to your information. The higher of the two pensions will get your personal allowance and the lower pension will be taxed at 20% of all taxable income again you need to keep records but it looks as if you will pay some tax on your DC pension therefore this will probably get your personal allowance. Both these pension companies will advise HMRC that you are being paid as of the beginning of the tax year or in the case of the drawdown pension when you take a top up.[/FONT]
[FONT=&quot] [/FONT]
[FONT=&quot]Scenario 3) Your Tax code on your DC pension will be probably be reduced by the state pension value therefore you pay tax for the DC and state pension to the DC pension company on taxable earnings.[/FONT]
[FONT=&quot] [/FONT]
[FONT=&quot]The top ups from your drawdown will be taxed at 20% assuming the top ups are less than the DC pension.[/FONT]

Albermarle

there are potentially 3 pensions and each of the 3 sources don't know about the other 2

.
Yes but as said already HMRC will know and will allocate allowances accordingly .
In a simplistic comparison it is the same as having two jobs . For the primary job the personal allowance is allocated to that , and for the second job you will have a tax coding of zero , so will pay tax on everything.
You will need to monitor closely during the first few years until your situation settles down . Almost certainly there will be some under/over payments that will need to be adjusted for.

Linton

To answer the question in the title....
Pensions, other than state pension, are taxed by the pension company under PAYE in exactly the same way as your employment earnings would be. HMRC will allocate a separate tax code to each "employer". State Pension is taxed by reducing your tax allowance by the value of the pension.

agent69

Many thanks for the replies. I never realised you could have more than one tax code.


So taking one step at a time, in scenario 1 I take £16k a year in draw down, which will be £4k tax free and the remaining £12k equates to my annual allowance, so there should be no tax payable.



I assume that when I give up work with my current employer they notify the tax man of this? So when the drawdown company tell HMRC that they are paying me £1333 a month, HMRC will realise this is my only income and issue the appropriate tax code corresponding to nil tax?



If I do a bit of agency work the agency will contact HMRC, who will know that my tax free allowance has been used up, and issue a code to the agency that effectively says tax all income.


Does this mean that I don't need to contact HMRC to tell them of my revised situation?

Albermarle

I take £16k a year in draw down, which will be £4k tax free and the remaining £12k equates to my annual allowance, so there should be no tax payable.

Normally drawdown means taking all the tax free cash first and then drawing a potentially taxable income from the remaining 75%.What you propose is taking your pension by the UFPLS route , where when you take a sum of money , the 25% is tax free and 75% is taxable .
It is a perfectly valid way of taking pension money but is it is not drawdown.

comeandgo

agent69 wrote: »

Many thanks for the replies. I never realised you could have more than one tax code.


So taking one step at a time, in scenario 1 I take £16k a year in draw down, which will be £4k tax free and the remaining £12k equates to my annual allowance, so there should be no tax payable.



I assume that when I give up work with my current employer they notify the tax man of this? So when the drawdown company tell HMRC that they are paying me £1333 a month, HMRC will realise this is my only income and issue the appropriate tax code corresponding to nil tax?



If I do a bit of agency work the agency will contact HMRC, who will know that my tax free allowance has been used up, and issue a code to the agency that effectively says tax all income.


Does this mean that I don't need to contact HMRC to tell them of my revised situation?

HMRC know nothing, you have to tell them everything and you will
probably have to complete your own tax returns too.

drumtochty

agent69 wrote: »

So taking one step at a time, in scenario 1 I take £16k a year in draw down, which will be £4k tax free and the remaining £12k equates to my annual allowance, so there should be no tax payable.



I assume that when I give up work with my current employer they notify the tax man of this? So when the drawdown company tell HMRC that they are paying me £1333 a month, HMRC will realise this is my only income and issue the appropriate tax code corresponding to nil tax?



If I do a bit of agency work the agency will contact HMRC, who will know that my tax free allowance has been used up, and issue a code to the agency that effectively says tax all income.


Does this mean that I don't need to contact HMRC to tell them of my revised situation?

In 1) You will have taxable income of £12,000 but your personal allowance will cover this and no tax will be deducted there may be some early hickups but they will be sorted.


When you leave full time employment your employer via the PAYE system will advise HMRC electronically that you have ceased working for them and electronically HMRC will have your earning detail from that employment but it will take up to six weeks for all the HMRC systems to be updated due to the various salary payment dates and dates that your old employer payrol batch updates the HMRC system and reports your final earnings to HMRC.



At the same time your employers personel department will write to the their pension department or outsourced pensions admin to advise them that you are no longer employed.


You will have advised the pensions department when you want to start taking your DB pension which you have advised is in the future.


There is no need for you to tell HMRC you are no longer working.


If you take your drawdown ASAP after stopping working it will take a month or so for HMRC to sort things out, maybe a short while to get the tax codes in place as your employers final payrol data may arrive with HMRC after your first drawdown payment.


All things being equal you do not have to advise HMRC as your employers and pension providers will do this for you. Be prepaied for some issues like posibly having to phone HMRC re your agecy tax code if they get confused between you drawdown provider and your agency earnings.


You will probably have to still fill in a tax return for a few years until things settle down, therefore keep your paperwork and payment details easily to hand.

mgdavid

agent69 wrote: »

........
I assume that when I give up work with my current employer they notify the tax man of this? ..........

No - *never* assume anything.
You need to have a conversation with the taxman whenever your circumstances change otherwise you usually end up paying too much or too little tax (and have to sort it out later on anyway).