Is the income I receive from my pension annuity tax-free?

16th April 2012

After paying tax throughout your working life, when it comes to annuities and retirement in many cases you would feel that it’s time for a little tax break, unfortunately this is not the case. Although many annuity incomes are subjected to lower tax rates (due to the increased personal allowance of many pensioners) you are still required to pay income tax in the same way that you would if you were working.

What is a tax-free lump sum?

When you choose to take out an annuity and retire you are eligible to take a tax-free lump sum of cash which can be any amount up to 25% of your existing pension pot. Many people choose to take a tax free lump sum and spend it on a holiday or another major investment. For others, they choose to invest it in something far more high-risk than an annuity, such as the stock market, or even in property – something designed to be high-risk and high return.

What taxes am I expected to pay on my annuity income?

Although annuities are designed to provide you with an annuity income, they are still a form of income and as such they are subject to income tax in the same way that any earned income is. This means that if you are a base rate taxpayer then you will be taxed at the same 20% rate that you would pay if you were in employment.

Your tax is deducted through a PAYE (Pay as you earn) system, similar to that if you were working and as a result your tax will be deducted from your annuity income before you receive it.

As with any form of tax, you will receive a completed P60 form at the end of the year detailing how much tax you have paid, this can form the basis for a case if you feel that you have overpaid tax during the year.

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