Claiming state pension?
Just bear in mind that the tax on it has to come from somewhere, cautions Paul Lewis.
Many people ask me, “Why has my income tax gone up since I claimed my state pension?” – often in a state of shock! This happens because the state pension is taxable, even though it is paid gross without any tax due being deducted. The tax on it has to come from somewhere, and the easiest way for HMRC to collect it is to take more tax from your other income, such as earnings if you still work, or a company or private pension. So it reduces your tax code that is sent to your employer or pension payer, which starts taking more tax off you.
For most people under pension age their tax code is 1257L. The numbers represent the personal tax-free allowance of £12,570 with the last digit knocked off. That tells your employer or pension payer how much tax to take off.
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But once you claim your state pension all this changes. Suppose your state pension is the average, which is now around £200 a week or £10,400 a year. This is taxable money but is paid in full without any deductions. So that £10,400 uses up most of your tax-free allowance, leaving just £2,170 tax-free for the rest of your income. Your tax code will be reduced to L217, which means your other income will have much more tax taken off it. It may seem unfair but it’s just how the system works. Overall, the tax taken off your income should be right.
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If your state pension is more than your tax-free allowance – and about 2.5 million now are – then your code may begin with a K, which means extra tax is taken off your other income to take account of the tax due on some of your state pension. If you live in Scotland or Wales your tax code will begin with an S or a C (for Cymru). At the end of the tax year it’s worth adding up all your income from different sources, then deducting the personal allowance of £12,570. Your tax should be roughly a fifth of that answer if you don’t pay higher rates of tax.
Learn more by searching “tax codes” at gov.uk or calling the tax helpline on 0300 200 3300.