State pensioners have been issued a warning that they could be slapped with an unexpected tax bill from HMRC this year.
A lot of people mistakenly believe that state pension income is tax-free. Unfortunately, it is just as subject to tax rules as any other form of income and in fact, if you have some small savings, you can quickly run over the threshold and be stung with a tax bill.
The state pension this year is roughly £11,500 while the Personal Allowance Threshold stands at £12,570.
That means you only need to earn £1,070 in a year on top of your state pension to become eligible to pay some tax on your earnings.
There are many potential sources of income which count towards your tax bill, including any work you’re paid for, self employed side hustles, savings interest and other private pensions.
For example, if you have an annuity, which is a guaranteed income from your pension pot, you can take 25 percent out tax free as a lump sum but any regular annual income from the annuity is subject to tax.
If you were to make any further withdrawals from your private pension pot in a tax year after the 25 percent lump sum, those withdrawals would also be subject to tax, whether as income drawdown or taking more of your pot out in one go.
And you really don’t need to take much out of this before you start running over the thresholds for tax.
For example, if you received the full state pension of £220 per week, or roughly £11,500 a year, then took a further £1,500 from a private pension in annuity payments or withdrawals beyond your lump sum amount, you’d be on approximately £13,000 income, meaning about £470 would be subject to tax at 20 percent.
Then if you had savings of £7,500 in a three-year fix at 5 percent interest, and that fix paid out in the same year, you’d get just over than £1,000 of interest paid in one go. The first £1,000 would be interest-free due to the Personal Savings Allowance, but the rest would be subject to tax.
There is also something called the Starting Rate for Savings, which can give you tax free interest up to the first £5,000.
The government says: “You may also get up to £5,000 of interest and not have to pay tax on it. This is your starting rate for savings.
“The more you earn from other income (for example your wages or pension), the less your starting rate for savings will be.”
As soon as your income hits £17,570, including from pension income, you won’t be eligible for this either, though.
As Money Helper says: “After you’ve retired, you still have to pay Income Tax on any income over your Personal Allowance.
“This applies to all your pension income, including the State Pension.
“Many people assume that their pension income – especially the State Pension – will be tax-free, but that’s not the case.
“Some income, including your State Pension, is paid without any tax being taken off. But it doesn’t mean that tax isn’t due.
“If you have to pay tax on your State Pension, this will usually be collected through any personal or workplace pension you might have.
“When you’ve reached the age you’re allowed to access it you can take money out of your pension as and when you want.
“However, usually only the first 25 percent will be tax-free. The rest is taxable as earnings. The tax rate you pay increases when your income goes over the income tax thresholds.
“This means that the more money you take from your pension pot, the higher your tax bill could be.”
