How does the State Pension Tax Work

FIRSTTIMER

Hypothetically speaking....

If say you have an unfunded government pension (NHS/TPS etc) that is paying you on retirement at say 65....

£150,000 25% Tax Free Lump Sum
£25,000 Pension Annually.

State Pension then kicks in 3 years later at 68, let's say it is £1000 a month.

That means an annual salary of £37,000 which is liable for tax?

I was under the impression that the state pension isn't taxable and have just had a realisation that however much you try and top up government funded pensions etc, you will end up paying tax back in some form or another at retirement due to the fact of topping up to try and get a comfortable retirement!

I am beginning to think it's cheaper to just save the extra cash in a S&S LISA rather than a SIPP? Or maybe its just Sunday evening blues!

Nick_C

State Pensions are taxable. So are occupational pensions.

And let's face it, if your pension is £25k you an afford to pay a bit of income tax on it.

You don't pay NICs (currently), so pensioners are very much better off than workers with the same gross income.

Re "how does it work", the tax due on your SRP is collected from your occupational pension under PAYE by adjusting your tax code.

Silvertabby

The State pension has always been taxable income - it's just that DWP don't have the means/inclination to tax it at source.

What happens is that it will be paid regardless of any tax due, but that your (other income) tax code will be adjusted in order to take the tax due from your State pension.

FIRSTTIMER

Thanks - I honestly thought State Pension was tax free! I might now reconsider piling all my spare cash into extra SIPP pensions actually and go for a S&S LISA to use as cash and thus bring my income down to avoid paying more tax in retirement years!!

ex-pat_scot

FIRSTTIMER wrote: »

Thanks - I honestly thought State Pension was tax free! I might now reconsider piling all my spare cash into extra SIPP pensions actually and go for a S&S LISA to use as cash and thus bring my income down to avoid paying more tax in retirement years!!

Doubtful.


In general terms, you would get 32% (basic rate) or 42% (higher rate tax) relief, plus employer matching contributions, for any payments you made into company pension.
When you withdraw this money in retirement, then 25% of it will be tax free and the remaining 75% will be taxed at your marginal rate. Ie 20% for total income £12,500 to 45,000 and 40% above that.


Thus the tax relief on the way in, plus tax free lump sum plus reduced tax on the way out (ie no NI) gives it a huge advantage over ISA/ LISA.


Oh and your state pension (max) would be £700 per month, not £1000 per month. Quite a difference, if it is a significant part of your planning.

Nick_C

ex-pat_scot wrote: »

In general terms, you would get 32% (basic rate) or 42% (higher rate tax) relief, plus employer matching contributions, for any payments you made into company pension.

20% rate surely, not 32%.

NICs are calculated on gross pay, not taxable pay.

Paul_Herring

Nick_C wrote: »

20% rate surely, not 32%.

NICs are calculated on gross pay, not taxable pay.

If it's salary sacrifice, it's 32%/42% since NIC isn't calculated on any contributions.

If it's net-pay or relief at source, it's 20%/40% since NIC is calculated before contributions.

p00hsticks

FIRSTTIMER wrote: »

Thanks - I honestly thought State Pension was tax free! I might now reconsider piling all my spare cash into extra SIPP pensions actually and go for a S&S LISA to use as cash and thus bring my income down to avoid paying more tax in retirement years!!

Bear in mind that (assuming any contributions to a S&S LISA or a SIPP will be from your net pay) you'll get pension relief added t\o your SIPP payment, but not your LISA.

When you come to take money out, then (by current rules) all the money in your LISA is tax free, while only 25% of the money in your SIPP is.

So it's swings and roundabouts - tax savings now or later. If you are likely to pay tax at a lower rate during retirement (e.g. higher rate tax payer now, not in retirement) then it usually makes more sense to put it into the pension.

AnotherJoe

FIRSTTIMER wrote: »

Thanks - I honestly thought State Pension was tax free! I might now reconsider piling all my spare cash into extra SIPP pensions actually and go for a S&S LISA to use as cash and thus bring my income down to avoid paying more tax in retirement years!!

Do the exact maths for your circumstances.

Then you'll find that in most circumstances, and certainly if you are currently a higher rate tax payer, pension beats LISA.

Silvertabby

FIRSTTIMER wrote: »

Thanks - I honestly thought State Pension was tax free! I might now reconsider piling all my spare cash into extra SIPP pensions actually and go for a S&S LISA to use as cash and thus bring my income down to avoid paying more tax in retirement years!!

This is a very common mistake, probably because most of those with just the State pension to live on don't pay tax as their income is less than their personal tax allowance.

Wouldn't like to count the number of 'phone calls I took from LGPS pensioners, complaining that their LGPS pension had 'gone down'. My explanation that they were paying tax/more tax from their LGPS pension in lieu of the tax due in respect of their State pension rarely went down well - some even demanded to speak to 'someone who knew what they were talking about', as 'everyone knows that the State pension is tax free'.

Slightly off piste - during my time in the Armed Forces, it would wind me up no end when 'civvies' insisted that it was 'all right for me' - as everyone knew that members of the Armed Forces didn't pay income tax, NI, MQ rent (including gas/electric), single accommodation/food charges, etc etc.

Dazed_and_confused

This is a very common mistake, probably because those with just the State pension to live on don't pay tax as their income is less than their personal tax allowance.

Not in all cases. There was a thread recently on the Cutting Tax board from someone who has a parent with unusually high State Pension which was over the Personal Allowance.

But this will obviously be less common going forward as more and more people get the new standard amount of £164.