When people ask us about their pension pots, one of the most common questions is, are pensions taxable? While we are not qualified tax advisers and do not provide tax advice, at Cameron James we have extensive experience with pensions. This means we can offer you a straightforward, layman’s explanation about how pension taxation generally works in the UK.
Watch our CEO and Independent Financial Adviser, Dominic James Murray, explain the key points about UK pension tax in this short video. Subscribe to our YouTube channel for more expert insights, updates, and tips on UK pension transfers and taxation.
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UK Government on Pension Tax
Pensions are often not taxable. This means that the government, which permitted the pension system to exist, provides for incentives. The government does not tax your pension funds. Why do governments do that? Let us illustrate with an example. The UK government does not want everyone to reach the age of 70 with no money. Doing so would force it to provide more funding to these residents, which would be a dreadful outcome.
As you are aware, in the United Kingdom you accumulate a state pension, also known as a government pension. This is based on the number of years and national insurance contributions you have made. UK State Pensions and UK Private Pensions are free from Capital Gains Tax (CGT). I.e. there is no capital gains tax on any of the increases in your pension value(s) throughout your lifetime. However, when you withdraw money from your pension fund, you are subject to taxation in the form of income tax, if your annual pension income (including all forms of other income) exceeds your annual allowance of £12,570 (2022/23).
Reason to Get Tax on UK Pension
Why should pension members be charged on their pension? The UK government is supporting you with a tax incentive on your contributions on the way into your pension account. But when you go to withdraw that money later in life, it's not unreasonable for the UK Government to want to tax you on that money because they did help you out earlier on, so what this means is that pensions are not normally taxable until you start drawing that income down, at which point it is taxed at your marginal tax rate.
This is a critical point for pension assets; you should always aim to expand your UK pension assets as much as possible because there is no capital gains tax until you pull it down, at which point you will be subject to income tax.
UK Double Tax Treaties
However, if you reside outside the UK, just because you have a UK pension does not mean that are pensions taxable applies in the UK for you. Whether your pension is taxed depends on your country of tax residence at the time. For example, if you live in France, you declare your pension income on your French tax return. If in Spain, on your Spanish tax return. If you retire in the United States, on your American tax return, and so on and so forth. This means you won’t be taxed twice on your pension in both the UK and your country of residence.
How to Declare Tax in Country Residence?
Many of our clients who have reached retirement age ask us, “How do I do this?” and “How do I declare my taxes in my country of residency?” Once again, we are unable to help. We cannot report taxes on our clients’ behalf. The pension providers we deal with can offer a very neat breakdown of what your income has been from that pension fund during retirement, which you can subsequently declare on your tax return.
Pension Commencement Lump Sum
There is a very interesting scenario that comes with the PCLS or pension’s pension commencement lump sum. To provide some context, the PCLS is your pension commencement lump sum from your UK pension. The UK government has put in place laws that stipulate you may receive the first 25% of your UK pension tax-free at the age of retirement. Presently, this is 55 and will be 57 in 2028.
US & UK Tax Treaty – Is the 25% PCLS tax-free in the USA?
But can this 25% of PCLS be included in the United States, you ask? We'll talk about the UK-US tax treaty and whether your 25% PCLS is tax-free in the United States. As you can see from our US website, we have many clients across America. Therefore, we are often in conversations with clients about whether their 25% of PCLS is tax-exempt in the US.
If you have moved your pension or accessed your pension from the United States, many of our clients believe that the 25% of PCLS will be tax-free in the United States. It is essential to highlight, once again, that we are not tax advisers. At Cameron James, we will never send you a tax letter. We will always urge you to seek independent tax advice in addition to our financial advice.
However, if you read the UK-US tax treaty, you'll see that it's not quite as black and white as that. Anyone who believes they can just take the 25% tax-free from their UK pension and pay no tax on it in the US without having to complete any paperwork is in for a surprise, and it might be something that you get called out on later in life.
We need to think about this objectively. If you are English with a UK pension living in the US, you have the same tax rules as everyone else. US pensions do not offer a 25% tax-free allowance. So, why would the US let you benefit from a better pension and tax system than its own citizens? This question starts the debate.
There are many financial advisory companies out there. If you search online for “25% is tax-free in the United States,” you’ll find 10 to 15 advisers claiming it’s tax-free. However, they are not tax advisers and are not qualified to give tax advice. You should always seek independent tax advice.
Why Do You Need Tax Adviser Service?
Navigating pension tax, especially if you live outside the UK, can be complex, particularly when considering the 25% pension commencement lump sum and how UK-US tax treaties apply. At Cameron James, we always urge clients to seek independent tax advice to ensure compliance with local tax laws and to optimise their pension income.
If you’re still unsure whether pensions are taxable in your situation or how to manage your pension tax efficiently, don’t hesitate. Book your free consultation with one of our experts today and take control of your pension future with confidence.