Taxation of Pensions
Which pension benefits are always taxable?
Some benefits from the pension scheme are always taxable. For example:
- Pensions in payment, whether they are paid to you as a member or to your spouse or dependants, are always taxable at your marginal rate.
- Refunds of contributions if you leave with short service are taxable at, currently, 20% on the first £11,500 and 40% thereafter.
Some benefits are not normally taxable. For example:
- Pension Commencement Lump Sum on retirement
- Lump sum benefits payable on death are not normally taxable
- Transfers of scheme benefits do not normally trigger tax payments
However, there are other taxes, in addition to the above, that might become payable by you as an individual if your pension benefits are significant.
Is there an annual check on the total benefits I can earn?
There is no absolute limit but you will pay additional taxes if you exceed the Annual Allowance. Each tax year you are liable to declare to the Inland Revenue if you have earned pension which exceeds the Annual Allowance in value. The Annual Allowance is usually £40,000. but the rules have now become excessively complex. If you have taken advantage of any of the 2015 “pension freedoms”, or if you have income (including pension and benefits in kind) of over £150,000 then different rates may well apply.You can find more guidance on this topic by the link the “Taxation of Pension Accrual” page.
Is there a maximum check on the total benefits I can be given?
There is no absolute limit but you will pay additional taxes if you exceed the Life Time Allowance. If you draw a pension or a lump sum at retirement, or if you die and a lump sum benefit becomes payable, or in one or two other unusual situations, this counts as a "benefit crystallisation event".
Each benefit crystallisation event has a value. When it is a lump sum payment the value is simply the amount of the lump sum. When it is a pension it is normally 20 times the initial amount of the pension although different rules can apply to pensions bought from AVCs.
There is a maximum total amount of benefit crystallisation that you can ever have from UK pension schemes without triggering additional taxes. This maximum amount is known as the Life Time Allowance. Details of the current Life Time Allowance can be found on https://www.gov.uk/tax-on-your-private-pension/
If you ever exceed the Life Time Allowance, you will incur additional taxes of 25% on the excess benefits when they are drawn. The pension scheme administrators will be obliged to deduct this tax. In addition, all subsequent benefits that you draw from any UK pension scheme will incur the additional taxes at the point you draw them.
Whenever a benefit crystallises for you, you will be told what percentage of the Life Time Allowance this accounts for and what percentage you have left. You will need to provide this information to the administrators of any other pension schemes you have where you have not already drawn all your benefits before they can put your benefits into payment.
Can I protect myself against the tax on benefits over the Life Time Allowance?
There have been various ways of protecting yourself against the Life Time Allowance and against reductions in the amount of the Allowance. If you do not already have such protection then the approaches available in 2006 and 2012 are no longer available.
It is still possible to apply for individual protection against the fall in the Life Time Allowance from £1,250,000 to £1,000,000 at 6 April 2016 and currently there is no application deadline.
This is a very complicated area and if you think it might apply to you, you should seek Independent Financial Advice.
I have already protected myself against the new taxes - what should I do?
You should contact the Pensions Team to register your protection with the Scheme.
I believe I already have enough pension benefits to reach the Life Time Allowance - what should I do?
You may be able to opt out of the Scheme and receive alternative benefits. Contact the Pensions Team for more details.
