Some pensioners are being hit with unexpected tax bills months after their income increases because the State Pension is paid without any tax being deducted upfront.
Some pensioners are being hit with unexpected tax bills months after their income increases because the State Pension is paid without any tax being deducted upfront.(Image: Getty Images/iStockphoto)
Although the State Pension counts as taxable income, HM Revenue and Customs (HMRC) does not take tax directly from the weekly payments. Instead, any money owed is usually collected later, often through adjustments to a PAYE code on a workplace or private pension, employment earnings or a tax bill.
This can catch people off guard, particularly those who also receive extra income from a private pension or part-time work. When a new income source like the State Pension starts, HMRC may try to collect the tax due by changing the tax code applied to another income stream.
That could mean more tax is taken from a workplace or private pension to make up the difference. However, these adjustments do not always happen straight away or accurately.
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If too much of the Personal Allowance is applied across multiple income sources, an underpayment can quietly build over several months.
In some cases, people may not realise anything is wrong until HMRC updates their tax code later in the year or sends a calculation showing tax is owed.
Flexible pension withdrawals can also lead to confusion. HMRC data shows that between October and December last year, more than £49 million was repaid to people who had overpaid tax after taking money from their pension.
This often happens because the first withdrawal is taxed using an emergency code, which assumes the same amount will be taken every month. That can result in a much higher tax deduction than expected at the time.
Although the position is usually corrected, some people do not realise they can reclaim the overpaid tax, or delay doing so.
Other sources of income can add to the problem. Certain benefits, including contribution-based Employment and Support Allowance and Carer’s Allowance, are also taxable but may be paid without tax being deducted.
Where there is no obvious income stream for HMRC to adjust, any tax due may instead be collected through a bill.
The issue is becoming more common as more pensioners rely on a mix of income in retirement, including the State Pension, private pensions and, in some cases, earnings.
The main thing to remember is that the State Pension should not be viewed in isolation, it needs to be considered alongside all other income when working out how much tax may be due.
Checking tax codes when income changes and keeping track of total annual income can help reduce the risk of a surprise bill later on.
