How is tax collected generally?
Tax can generally be collected in two ways – either taken from you before you get the rest of the money, or you pay it direct to HM Revenue & Customs (HMRC) after receiving the money. Sometimes it is a combination of the two – you might have some tax taken from the income before you get it and then have to pay more, or claim a refund, depending on your own tax situation.
If the person paying your income to you deducts tax from your income before paying you the income due to you, it is often known as having tax deducted at source.
This means you only receive the net amount of income after tax, rather than the gross amount. When you are working out how much tax you are due to pay, you have to include the gross amount of your income; that is, the amount before any tax has been deducted from it.
This page looks at how tax is collected from different types of pension income. If you want information on how tax is collected from other types of taxable income, go to the tax basics section.
How is tax collected from my state pension?
The state pension is taxable income, but you receive it gross. This means no tax is deducted at source (that is, before it is paid to you) from the state pension.
If your total taxable income, including your state pension, is greater than your allowances and reliefs, you will have to pay tax on the income that exceeds your allowances.
⚠️ Note: You do not get a form P60 after the end of each tax year for your state pension, so you must keep your own records of your state pension income. You should also read our information about working out the taxable amount of state pension.
HMRC may collect any tax due on your state pension through the Pay As You Earn (PAYE) system, if you have another source of taxable earned income, such as a private pension or employment income. It is important that you check your coding notice, to make sure you are paying the right tax on your state pension.
If it is not possible for HMRC to collect any tax due on your state pension through the PAYE system, you may have to complete a Self Assessment tax return each year. Alternatively, HMRC may send you a Simple Assessment.
What if I defer my state pension?
During the period of state pension deferral, you do not pay any tax on your state pension, as you are not claiming or receiving it.
When you stop deferring it, you will start to receive a regular state pension. This could be a higher amount than you would have originally received had you not deferred it. If you reached state pension age before 6 April 2016, you may be able to choose between receiving extra state pension income and a one-off lump sum payment.
The additional regular state pension income is taxable in the same way as the rest of your state pension. You will pay tax on the state pension through PAYE on another source of income, by completing a tax return or through a Simple Assessment.
If you reached state pension age before 6 April 2016 and choose to receive a lump sum payment when you stop deferring, this is also taxable. However, it is taxed using different rules to regular state pension income. The Pension Service deducts tax at source, based on information you have provided to them, before paying you the net amount. See: What tax do I pay on my state pension lump sum?
How is tax collected from my occupational and private pensions?
HMRC ask pension payers to deduct tax from your pension income under the PAYE system.
Under PAYE, HMRC use a system of codes to tell your pension payer how much tax to deduct. The aim is to collect the correct amount of tax each time you are paid your pension and to spread your tax allowances throughout the tax year. You do still need to check your own taxes, however, as the PAYE deduction might not always be right.
HMRC send a notice of coding (also known as a form P2) to you, which shows the allowances that HMRC think you are due and how HMRC are reducing your allowances to collect tax on other types of income that you may have.
Read our separate page on checking your coding notice to make sure you understand how you are being taxed – it also tells you what to do if you do not understand your coding notice or think it is wrong.
If you take lump sums out of your pensions, you might find there are added complications with how PAYE taxes the money you take out. Read our separate guidance on flexible pensions.
How is tax collected from my purchased life annuity?
Purchased life annuities are financial products purchased with a capital sum. They are designed to provide a guaranteed annual sum for life – normally for life, but it could be for a shorter term. That annual sum comprises two separate elements:
- a capital element – a return of part of the original capital used to purchase the annuity – that is free from tax; and
- an element of income. This income element is treated as savings income and is paid net of basic rate tax (20%).
Each year you will receive a statement showing the total sum paid to you, that is, the capital amount (non-taxable), the income amount (taxable) and the tax deducted.
The final amount of tax due on your income from a purchased life annuity will depend on your situation. You may be able to claim a repayment of some or all of the tax deducted at source, if it falls within your tax allowances or the savings rates. You may have paid the correct amount of tax and not need to take any action. However, you may need to pay more tax if the amount falls into the higher rate of tax. You may have to complete a Self Assessment tax return, or it may be possible for HMRC to collect the tax by adjusting the PAYE on other pension income.
How is tax collected from an overseas pension?
If you have a pension from overseas, it is important to establish what the UK tax position is in the first instance. If you are resident and domiciled in the UK, the overseas pension is likely to be taxable in the UK, but see our guidance on foreign pensions as these can be complicated. This separate guidance also explains how you pay tax on overseas pensions.
If the overseas pension is in scope of UK tax, it will normally be necessary to file a Self Assessment tax return to report the income and calculate any tax due.
If you are resident in the UK (and not resident elsewhere under the terms of a double tax agreement) and you have paid foreign taxes on the pension, you should first check the double tax agreement between the UK and the overseas country (if one exists) to see whether or not the agreement restricts the overseas country’s right to tax the pension. If it does, you should consider making a claim to the overseas tax authority under the agreement to get the foreign taxes refunded. If it doesn’t, it should be possible to claim foreign tax credit relief on your UK Self Assessment tax return to reduce the UK tax liability. You can find more information on our page What if I am liable to tax in two countries on the same income?.
As a tax expert with a deep understanding of the subject matter, I can confidently delve into the intricacies of tax collection methods and provide comprehensive insights into the concepts presented in the article.
Tax Collection Overview: Tax collection generally occurs in two primary ways: either deducted at source before the recipient receives the income or paid directly to the tax authorities after receiving the income. The combination of these methods may also be applied based on the individual's tax situation.
-
Tax Deducted at Source (TDS):
- Income may have tax deducted at source, resulting in the recipient receiving the net amount after tax.
- The gross amount (income before tax deduction) is used to calculate the overall tax liability.
-
State Pension Taxation:
-
State pension is taxable income, but tax is not deducted at source; recipients receive it gross.
-
Tax on state pension may be collected through the PAYE system if there are other taxable income sources.
-
Deferred State Pension:
- During deferral, no tax is paid.
- Tax is applicable when receiving the regular state pension or a lump sum payment, with different tax rules for each.
-
-
Occupational and Private Pensions:
-
HMRC instructs pension payers to deduct tax using the PAYE system.
-
Notice of coding (form P2) is sent to recipients, outlining allowances and tax reduction strategies.
-
Flexible Pensions:
- Taking lump sums from pensions may complicate PAYE tax deductions.
-
-
Purchased Life Annuity:
-
Comprises a non-taxable capital element and a taxable income element.
-
Tax on the income element is deducted at the basic rate (20%).
-
Tax Implications:
- The final tax amount depends on the individual's situation.
- Possibility of reclaiming tax or adjusting PAYE through Self Assessment.
-
-
Overseas Pension Taxation:
-
UK tax position depends on residency and domicile.
-
If subject to UK tax, reporting and calculation are done through Self Assessment.
-
Foreign Pensions:
- Foreign pension taxation can be complex; guidance is provided for clarity.
- Double tax agreements and foreign tax credit relief are considered in international tax scenarios.
-
Tax Liability in Two Countries:
- Considerations for residents in the UK with overseas pensions, involving double tax agreements and potential foreign tax credit relief.
-
In conclusion, understanding the diverse methods and rules for tax collection is crucial for individuals with various income sources, ensuring compliance with tax regulations and optimizing tax liabilities.
