How your state pension is taxed
The news that the state pension is to rise to nearly £12,000 next year will be welcomed by many retirees, but will leave others asking whether they will now be forced to pay income tax on their pension income.
The triple lock guarantee, introduced in 2011, means that each year the state pension rises in line with either inflation, average earnings growth or 2.5pc, whichever is highest. For 2025-26, average earnings are likely to be used, which would see state pension payments rising by 4pc for more than 12 million retirees from April 7, 2025.
However, income tax thresholds are frozen until 2028, meaning that increasing numbers of pensioners will be pulled into the tax net.
Here, Telegraph Money explains how the state pension is taxed, and how you can reduce the amount you pay. In this article, we will cover:
Is the state pension taxable?
The state pension is paid “gross”, meaning no tax is deducted when you receive it – but it is taxable. This means it contributes to your personal tax-free allowance.
If you only receive state pension income, or have very little additional income, you may still receive your state pension tax-free if your annual income is less than the £12,570 personal allowance. But anything over this amount is taxable, and it could be the rising state pension that tips you over the threshold.
If you receive the full new state pension, just £607.40 from other income sources will tip you into paying income tax. An estimated 300,000 people will be brought into paying income tax on their state pension as a result of next April’s rise.
The full new state pension, set to rise to £11,962.60, will account for 95pc of the personal allowance, which has been frozen until 2028. In 2021-22, state pension income only accounted for 74pc of the allowance.
Will I be taxed on my state pension?
You could be taxed on your state pension if your income exceeds the personal allowance.
You’ll only be taxed on the portion of your income that exceeds the £12,570 threshold. If you have other sources of income, this could get more complicated.
For instance, if you earn close to £50,270 – the threshold for paying higher-rate tax – the state pension increase could push you into the next rate of 40pc, up from 20pc.
Meanwhile, if you earn £99,999, the extra £460 would take your income to £100,459. You would then lose £229.50 of your personal allowance, because for every £2 you earn over £100,000, your personal allowance reduces by £1.
You then have to pay 40pc tax on earnings over £100,000, as well as on the £229.50 of lost allowance. After this you are left with £183.60 of the original £460 bonus, meaning you’ve effectively paid 60pc in tax.
How is the tax collected?
If you need to pay tax on your state pension income, HMRC will collect this differently depending on whether or not the state pension is your only source of income.
If you receive the state pension as well as a private pension, then your private pension provider takes off any tax you owe on both before they pay you via your tax code.
This is similar if you’re working beyond state pension age. In this case, any tax you owe from state pension income will be added to the tax you pay via Pay As You Earn (PAYE) through your tax code.
If the state pension is your only source of income, and you go over the personal allowance of £12,570, then HMRC should send you a Simple Assessment tax bill, which tells you exactly how much you owe and how to pay it.
If you already submit a tax return – to declare rental income, for example – you should add your state pension income once you start receiving it.
How can I reduce the tax I pay on my state pension?
If you’re concerned about being taxed on your state pension income, there are ways you can reduce the bill.
If you’re still working, you could defer your state pension payments. For every nine weeks you defer, you’ll get an extra 1pc when you come to claim. Your income will presumably drop significantly when you stop working, so waiting to claim the state pension will likely see you “keep” more of it.
In addition, salary sacrifice schemes allow you to swap part of your income for benefits such as pension contributions, or to buy an annual travelcard. It’s a great way to reduce your tax bill because if you “earn” less, you’ll pay less tax.
If you’re retired and have a private pension, take your time when withdrawing it. Drawdown rules allow you to take money directly out of your pension when you need it, and it could be prudent to reduce any regular drawdowns by the same amount as the state pension increase.
This means you won’t pay tax on money you don’t need yet, and the longer the money is in your pension pot, the more it’ll be worth when you do eventually withdraw it.
This can also benefit your loved ones, as pensions are currently not liable for inheritance tax. If you die before your 75th birthday, and it is transferred within two years, then they also avoid paying income tax on it as well. If it is not accessed for more than two years, or you die over the age of 75, then income tax is due at the rate of whoever inherits it.
Finally, the marriage tax allowance could save you up to £250 in tax annually. If you’re married or in a civil partnership, where one of you earns less than £12,570, and the other earns between £12,571-£50,270, the lower-earner can transfer £1,260 of their tax-free allowance to their partner, who can effectively earn more before paying any tax.
This makes a saving of £252 if you earn less than £11,310. However, you could encounter issues if you receive the full new state pension.
As the lower earner, “giving away” 10pc of your personal allowance means any income of more than £11,310 will be liable for income tax. Earn more than this, and you’ll have to submit a tax return to declare your income and pay the tax you owe.
