Are Pensions Taxable? Understanding UK Tax Pension
When it comes to pension pots, we are often questioned on whether they are taxable or not. The first important thing to note is that we are not tax advisors. Any advice we provide you at Cameron James cannot be considered tax advice; but we have spent most of our time dealing with pensions, so we are in an excellent position to give you a layman's perspective.
Watch a video explanation by our CEO and Independent Financial Advisor, Dominic James Murray, about the taxation of your UK Pension. Don't forget to subscribe for more tips, news and updates from the UK Pension Transfer industry that you should not miss.
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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, which means your pension funds are not taxed. 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. This would be a dreadful scenario for the UK government since they would be forced to provide more funding to these older residents.
As you are aware, in the United Kingdom you accumulate a state pension, also known as a government pension, 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 imply that you will be taxed on it in the UK. It will be determined by where you are a tax resident at the time. For example, if you live in France, you must declare on your French tax return; if you live in Spain, you must declare on your Spanish tax return; and if you retire in America, you must declare on your American tax returns. That is, you will not be taxed twice in the UK and elsewhere.
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, but 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, which is presently 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, time and time again we are in conversations with clients about whether or not 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 advisors. We at Cameron James will never send you a tax letter and 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're an English person, and you have a UK pension, and you live in the US, you're the same as everyone else there; they don't have a 25% tax-free allowance from their US pensions. So why would the United States allow you to come to their nation and benefit from a better pension and tax system than their citizens? This makes no sense, and this is where the debate begins.
There are many financial advisory companies out there; if you go to the internet and type in 25 is tax-free in the United States, you'll find 10 to 15 financial advisors who tell you that there's no problem; it's tax-free, but they're not a tax advisor, they're not qualified to give you tax advice, and you should always seek independent tax advice.
Why Do You Need Tax Advisor Service?
Some of our clients who are experts in this field are convinced the PLCS in the United States is quite complex, and they have the confidence to seek qualified advice from an independent tax advisor. On the other hand, we get some people who come in who don't have a solid financial background and say they saw online that it's 25% tax-free and they're pleased with that. This is critical, we recommend you seek comprehensive advice from a tax advisor.
At the end of the day, it's not our concern, and what they take from their pension and where they pay the tax is not our concern, but we like to be open and honest with our clients about the fact that we don't believe it will be as simple as having that 25 percent of your pension fully tax-free. At the very least, you will need to fill out some documents with your tax advisor and confirm that you have taken advantage of the tax treaty between the UK and the US.
Our advice is to always expect that 25% of your PCLS will not be tax-free in the US and to address this with your independent tax advisor in your state of residence.
