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Your pensions and tax

When you contribute to a pension scheme like Nest, you can benefit from tax relief.

When it comes to taking your money out of Nest, the amount of tax you pay depends on the option you choose.

At a glance - how pension withdrawals are taxed

  • When making withdrawals from your retirement pot, 25 per cent of each payment is normally tax-free. The remaining 75 per cent is taxed at your marginal tax rate.
  • Nest will deduct tax in line with HMRC guidance.

How am I taxed if I take money from my pension pot?

When you take withdrawals from your pot, 25 per cent will usually be tax-free. The rest is normally taxable in the same way as any income you’d earn, like your wages. This, when added to your other income, may increase the rate of income tax you have to pay in that tax year.

If you take a large amount in any one year, this could push you into a higher tax bracket. This means you might be paying tax at higher rates, even if you aren’t usually a higher rate tax payer.

Nest will always explain the amount of tax deducted. We will provide an estimate of this amount before you make a withdrawal and confirm the actual amount deducted once the withdrawal has been made.

We’ve provided some case studies below to show how Nest calculates the tax on any withdrawals you make.

Example 1 – making a one-off pension withdrawal 

Steve has £15,000 in his Nest pension pot. He decides to withdraw the whole amount when he reaches 65.

As we don’t have Steve’s tax code, we follow HMRC guidelines and use an emergency tax code - for example, 1250L - to calculate how much tax to deduct.

As 25 per cent isn't taxed, Steve can receive £3,750 as a tax-free lump sum

£15,000 x 25% = £3,750

We apply the emergency tax code to the remaining £11,250. The tax-free personal allowance under this code is £12,500 per year, which works out to £1,042 personal allowance each month.

As Steve is taking his pension in one lump sum, he can withdraw a further £1,042 tax free. 

£15,000 - £3,750 - £1,042 = £10,208

That leaves £10,208 taxed at the basic rate of 20 per cent.

£10,208 x 20% = £2,041.60

This means Nest will deduct £2,041.60 from the £15,000 withdrawal, meaning that Steve receives £12,958.40.

£15,000 - £2,041.60 = £12,958.40

Example 2 – making regular pension withdrawals 

Joanne has a pot of £20,000. She decides to start making regular withdrawals of £400 per month to supplement the State Pension and her part-time earnings as she has semi-retired.

As Nest doesn’t have Joanne’s tax code when the first payment is made, we follow HMRC guidelines and use the emergency tax code to calculate how much tax to deduct.

As 25 per cent is taken as a tax-free lump sum, Joanne receives £100 out of her £400 withdrawal (25 per cent tax-free allowance of £400 = £100).

We apply emergency tax to the remaining £300. The tax-free personal allowance under this code is £12,500 over the course of 12 months, which works out to £1,042 each month. 

As Joanne’s withdrawal is less than £1,042, we don’t deduct any tax. Joanne will receive the full £400.

By the time the second withdrawal is made Nest has received Joanne’s actual tax code from HMRC, which is 123L. The new tax code reflects other income Joanne has, including the State Pension. The second £400 withdrawal therefore has a different amount of tax deducted from it. The gov.uk website provides information on how HMRC issues tax codes

As 25 per cent is taken as a tax-free lump sum, Joanne receives £100 out of her £400 withdrawal (25 per cent tax-free allowance of £400 = £100).

We apply the correct 123L tax code to the remaining £300. The tax-free personal allowance under this code is £1,230 per year, which works out to £102.50 each month.

This means a further £102.50 can be withdrawn with no tax payable.

£400 - £100 - £102.50 = £197.50

So £197.50 will be taxable at the basic rate of 20 per cent.

£197.50 x 20% = £39.50

This means Nest will deduct £39.50 from the £400 withdrawal, meaning Joanne receives £360.50.

How am I taxed if I transfer my pot or buy an annuity? 

Nest won’t deduct any tax from transfers or payments to other providers to buy an annuity. Your new provider will let you know how they’ll deduct tax from your withdrawals or any income that you receive from them.

How am I taxed if I take my money due to ill health?

If you take your pot as a lump sum due to serious ill health and you’re under 75, it’s usually paid out to you tax-free. Once you’ve reached 75, we’ll need to take off income tax from the total amount in your pot.

Your annual allowance is the most you can save in your pension pots in a tax year before you have to pay tax on your pension contributions. You’ll only pay tax if you go above the annual allowance, which is currently £40,000 per year. If you take money out of your Nest pension pot then your annual allowance may be reduced to £4,000 per year. If you contribute over £4,000 to any pension schemes in a single year after your allowance is reduced, you may have to pay a tax charge on the amount that exceeds the limit. This restriction may not apply if you’re withdrawing your Nest pension pot completely and its value is less than £10,000. We’ll let you know whether this is the case when you request the withdrawal.

If you have accumulated retirement benefits across all pension schemes of more than £1,055,000 then you may have to pay extra tax on withdrawals. If you’re withdrawing the full amount of your pension pot and this is less than £10,000 then this may not count towards the lifetime allowance. We’ll let you know whether this is the case when you request the withdrawal.

Although we try to deduct the right amount of tax, we might not have all the information we need, like your current tax code from HMRC. It’s possible that you’ll need to pay more tax or have some tax refunded. If you think you should get a refund you can claim this directly from HMRC. 
If you think you’ve paid too much tax or believe you need to pay more, you don’t have to wait until the end of the tax year for the adjustments to be made. You can send a form to your local tax office for an immediate assessment. The form you need to complete depends on your circumstances. You can find the right form for you on the HMRC website or by calling them on 0300 200 3300.

If you die before turning 75 and we pay your pension pot to your beneficiaries or estate within two years, it’ll normally be paid tax-free.

You can find out more in the Tax and your pension pot section of our guide to Taking your money out of Nest. As tax is complex and depends on your personal circumstances, you may also want to get help from Pension Wise or a financial adviser. Nest won’t be responsible for any fees you may be charged for this service.

Disclaimer – To the best of our knowledge, all information in this article, including tax rates and allowances, is correct as at the time of publication, September 2020.

Last updated: 09/20

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