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Tax on deferred state pension?

Retirement | State Pension Helpful? 3

Asked by Charlemagne911, submitted 02 June 2011.

Open Quote My female friend is 65 in December and will be retiring from work 31/12/2011. She is a 40% tax payer; gross earnings around £57000 under PAYE. She has deferred her State pension for the past five years so is it advantageous for her to not take the lump sum available (approximately £32000 basic tax deducted) until the beginning of tax year 2012/13 when her tax rate will have fallen to basic rate level?

Also as her basic tax code for 2011/12 will increase to 9940 in December 2011 does this impact on the whole of the current tax year? If so is it desirable for her to contact HMRC now to tell them her intentions to retire as this will take her out of 40% bracket for this tax year, assuming she does not take any pension until the beginning of next tax year.
End Quote

Answered by Justin on 03 June 2011

If she takes the lump sum option from a delayed state pension the entire amount is taxable at the highest rate paid on her income that tax year. Given her gross PAYE income this tax year will be around £43,000 she'll be hovering around the higher rate threshold (£42,475) assuming she has no other income this tax year.

Because the lump sum isn't added to her income when calculating the tax owed (it's just taxed at the highest tax rate paid on other income that year), it'll be taxed at either basic or higher rate depending on which side of the line her income falls.

If she could arrange to be a non-taxpayer next tax year (e.g. by deferring other pensions) then she could potentially receive the deferred state pension lump sum tax-free, so there would be a benefit waiting until 6 April 2012 if this is feasible.

The increased age-related personal allowance applies for the whole tax year in which she turns 65, so a birthday in December means she'll enjoy the £9,940 allowance from 6 April 2011 to 5 April 2012. However, the allowance reduces by £1 for every £2 of income above £24,000, subject to not falling below the standard £7,475 allowance. So the extra age-related allowance will be fully wiped out by an income of £28,930 or more.

It would be sensible to contact HMRC to try and get her tax code changed so that she doesn't end up paying too much tax this year. However, I wouldn't count on them getting it right and suggest she double checks everything and reclaim any overpaid tax using form P50.

Please note this answer does not constitute a recommendation or financial advice and should not be relied upon when making specific investment or other financial decisions. You should always undertake your own research into whether a product or service is appropriate for your needs and, if necessary, use a qualified professional adviser.

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Readers' Comments (2) - To post a comment please register or login .

Comment by Charlemagne911 at 9:25am on 04 Jun 2011:

Not sure you have your calculations correct. Actual salary is £57444 so 9 months income will be approx £43000 which will creep into 40% bracket. At present a private pension contribution of £7000 pa pushes present tax code to 998L for which additional tax relief has been given, but this could be nullified by being so close to 40% threshold. However, many thanks for information that becoming a non-tax payer by deferring private pension for 2012/13 would allow full payment of deferred state pension.

Comment by justin at 9:35am on 04 Jun 2011:

Oops, sincere apologies, I've corrected my answer.