Taxation of pension payments explained

When accessing pension benefits, it's important to understand how taxation works. After withdrawing tax-free cash, the remaining balance will be subject to income tax. However, pension payments can sometimes be over-taxed due to the use of emergency tax codes, especially for one-off withdrawals.

As part of our Bitesize Technical series, Senior Technical Consultant, Joshua Croft explains the taxation of pension payments.

Key insights on taxation of pension payments

Income from pensions (annuity, scheme pension, or drawdown) is taxed via PAYE, using the tax code from HMRC. Until the correct tax code is provided, HMRC requires pension providers to use an emergency tax code on a "Month 1" basis, often leading to over-taxation.

HMRC adjusts the tax code after the first regular payment, but single withdrawals in the year may still result in excess tax.

With month one basis, only one-twelfth of the personal allowance is applied to withdrawals, potentially leading to higher tax deductions. HMRC corrects overpayments by the end of the tax year via the P800 process.

Overpayments can also be reclaimed within the year using specific forms.

• Form P53Z: If the payment used up the pension pot and the individual has other taxable income.
• Form P50Z: If the payment used up the pension pot and the individual has no other income in the tax year.
• Form P55: When only part of the pension is withdrawn, and you’re not taking regular payments.

Making a small initial withdrawal can trigger HMRC to provide a correct tax code for future payments.

More Bitesize Technical

Take a bite out of Ill health pension benefits explained, the next instalment of our pension benefits Bitesize Technical series, or start from the beginning, here.