How tax codes work


How tax codes work

As explained in the previous section (How Pensions are Taxed) the PAYE tax code for your main personal or occupational pension is normally adjusted to take into account the state pension you receive. This is because the state pension is taxable, but the Department for Work and Pensions does not deduct tax at source. Any other pensions or employment income would then usually be given  a BR PAYE tax code (= basic rate, i.e. 20% tax deducted).

One result of taxing the state pension in this way is that many pensioners have complex tax codes. The result can be even more complex if you are entitled to the married couple’s allowance or if you income is just over income limit for  ‘age related’ tax free personal allowance. This limit is £27,000 in 2014-15 and £26,100 in 2013-14. See the Personal allowance section for details.

Each pension will have its own tax code – so there should  be as many tax codes as there are pensions . These codes need to be checked. If they are incorrect then the total tax paid for the year is likely to be inaccurate. If you work as an employee as well as receiving a pension, then you will need to check the code for your work too.

An example – Tax on state and occupational pensions

James is 69. He has a state pension which is expected to be £5,880 for the year to 5 April 2015. He also has an occupational pension of £11,000 pa. As he was born before 6 April 1948, (but after 5 April 1938) he is entitled to tax free pay of £10,500 in the tax year 20014/15.

Tax free pay due                                                                                           10,500

Estimated state pension                                                                                5,880

Tax free pay remaining for occupational pension                                        4,620

To convert this into a tax code, the final digit is ignored. The PAYE code for the occupational pension would be 462P. (The ‘P’ indicates that the taxpayer was born between 6 April 1938 and 5 April 1948 and is expected to have income of under £27,000 in the year to 5 April 2015).

If James had another pension (or part-time work), in addition to the state pension and his main occupational pension, this would be taxed at basic rate = 20% with a ‘BR’ code.

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