Are you planning on withdrawing money from your pension? Is it your first time? Well, if you’re older than 55, then this is for you. It’s essential to understand tax implications when withdrawing money. You also need to know the time you have to pay emergency tax.
What Is Pension Tax Exactly?
You are eligible to withdraw 25% of their pension balance without having to pay tax if it’s your first withdrawal. So say the pension freedom rules. Income tax then needs to be paid on the remaining 75%. This tax will be charged according to your marginal rate.
However, your pension provider might give you an emergency tax code. This usually happens if you’re withdrawing money for the first time, the withdrawal being tax-free of course. Pension providers need to give you this code due to their tax code being out of date. This means that your total yearly earnings might not be accurate on their out-of-date code.
Is Emergency Tax Charged On My Lump Sums?
When you cash out a lump-sum and pay tax on it, you’ll be charged an emergency tax rate. However, if your pension provider has a valid P45, you won’t have to. If your provider has received an up-to-date tax code, which they receive from the HMRC, you also won’t have to pay the emergency tax rate. What exactly is P45 you might be asking yourself? It’s a documentation of your yearly earnings.
Pension tax is the same as income tax; it works in the same way. Your pension provider probably uses the PAYE (or Pay As You Earn) system when deducting tax. This is before you get your money. With PAYE, your payments receive will be handled as though they will be paid continually every month, just like it would with a regular salary or money coming in.
What does this mean for you? Well, if it’s the first payment that you’re making, you’ll be charged an emergency tax rate. This just means that your pension provider is ensuring enough tax for your predicted yearly earnings. This would be twelve times your annual withdrawal amount. You are allowed to receive only a twelfth of your money or allowance before tax has been charged.
How do you know that you’ll be charged an emergency tax rate on your pension withdrawal? When your tax code ends in ‘M1’ (meaning the first month). For most pensioners, they’ll be left with a tax overpayment. But this will then be recovered from HMRC.
Can I Be Refunded My Emergency Tax?
Yes, you can! The emergency tax on your pension can be reclaimed. Contact HMRC and get the ball rolling. Then, all they’ll do is look at your tax record to see if you have outstanding amounts due. If you don’t, your new tax code will be sent to your pension provider. They might use your new tax code to determine your future tax on withdrawals. This will, however, offset the amount that has been paid before. This is strictly at the discretion of your provider.
Now, if you’ve withdrawn your entire pension as a lump sum, you won’t be able to be refunded for your emergency tax. You can get overpaid tax refunded. You simply need to fill out an HMRC claim form. On the other hand, some people just wait until the end of the tax year. The tax refund happens then automatically.
Please feel free to contact your BeeKeeper. We will gladly answer any uncertainties you might have about your emergency tax or anything about your pension.
Some extra things to note:
There are a few topics that go together with emergency tax and pensions. Pension Plans, Pension Income, Service Credit and Social Security. Firstly, there are many different pensions plans out there. So you’ll need to check each one out very carefully when you’re planning your retirement and your future. There are workplace pensions, state pensions and then there are personal pension providers who offer many types of plans to suit everyone’s specific needs.
Secondly, Pension Income is also something to take note of. When you retire, you can also choose to retire earlier, you’ll be receiving an income on a monthly basis from your pension pot. If you decide to withdraw money from your pension earlier, your pension pot will be smaller, and your future monthly income amount will be decreased. So you’ll have to take this into consideration as well.
Thirdly, Service Credit comes to mind. What are they? Well, Service Credits are the sums that are taken from the amounts you owe to your pension supplier if its performance doesn’t meet the service level requirements.
Lastly, you’ll have to keep Social Security in mind as well. Social Security is a matter that’ll come up when you’re trying to claim your State Pension. What does it entail? You can only claim your State Pension if you have paid NIC or you have been given UK National Insurance contributions (NIC). What are NIC’s? These contributions are the UK’s social security contributions.
There’s a lot of things you need to know. Even though there is such a thing as emergency tax, doesn’t mean you should start stressing. Luckily, the first 25% you withdraw is tax-free and you can actually get back some of the tax you paid.