State Pension tax is another form of tax we will all likely face at some point in our retirement.
But what is State Pension tax and how much might you pay?
In this article we’ll explain what the State Pension is, how it’s taxed and how you can use other pensions to reduce your overall lifetime tax bill.
What is State Pension tax?
First of all let’s be clear on what the State Pension is.
The State Pension is provided by the UK government and is due to everyone at State Pension age providing you have paid enough National Insurance contributions.
National Insurance is another form of taxation that is usually deducted from your salary if you are employed or paid via your tax returns if you are self-employed.
In order to receive any State Pension at all you must have paid National Insurance for at least 10 years. To get the full State Pension you need to have paid National Insurance for 35 years.
At the time of writing the new full State Pension is £179.60 per week.
You can find out your State Pension age and get a forecast of what you could be due by using the government’s online State Pension Forecast tool. It’s free to use and gives you a really handy breakdown of your National Insurance record so you can see if you have any gaps you need to make up.
If you qualify for a State Pension it will be paid to you for as long as you live.
When you start to receive your State Pension it will be added to any other income you are already receiving. This could be:
- Income from a job if you are still working.
- Income from private or workplace pensions.
- Interest and dividends from investments.
State Pension tax is Income Tax paid on your State Pension.
If you already receive enough income that your Personal Allowance is used up then you may pay Income Tax on your State Pension at either 20%, 40% or even 45% if you are a very high earner in retirement.
At the time of writing the Income Tax bands and tax rates are as follows:
- Personal Allowance £12,570 – no tax paid on this income.
- Basic rate £12,571 – £50,270 – income in this band taxed at 20%.
- Higher rate £50,271 – £150,000 – income in this band taxed at 40%.
- Additional rate £150,000+ – income in this band taxed at 45%.
So if you were already earning £15,000 from other sources at the point you started to receive your State Pension your State Pension tax would be basic rate at 20%. So 20% of your State Pension would be taxed every year.
Being clever with State Pension tax
Nowadays if you have built up private pensions and investments, retirement can be a lot more flexible. You don’t need to wait until your State Pension age to retire.
You could in fact access your private pensions from age 55.
This also allows you to be a bit clever from a tax point of view.
If you were to retire around age 55 then that gives you 10+ years before your State Pension pays out.
During this time if you have no other earnings you will have a full Personal Allowance that can be used to make withdrawals from your private pension absolutely tax free.
This works brilliantly for defined contribution pensions using some form of flexible drawdown.
You could drawdown £12,570 from the ‘taxable’ part of your pension (but not actually pay any tax because it’s within your Personal Allowance) and then top up your income with tax free cash from your pension (up to 25% of your total pension pot should be tax free) or other investments like ISAs.
Then once you do reach State Pension age it is likely your State Pension will use up most of your Personal Allowance. So you could switch off or reduce your private pension income payments.
With private pensions, investments like ISAs and general investments accounts there are so many ways to generate income and legitimately avoid or reduce your tax bill.
Want to find out more? Why not get in touch for an initial consultation at no cost to you?
We’ll review your position and explain your options.
Tax doesn’t have to be taxing.
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.