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 £25,400 in 2012-13 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 67. He has a state pension which is expected to be £5,311 for the year to 5 April 2013. He also has an occupational pension of £11,000 pa. As he is over 65, he is entitled to tax free pay of £10,500 in the tax year 20012/13.

Tax free pay due                                                                                           10,500

Estimated state pension                                                                                5,311

Tax free pay remaining for occupational pension                                        5,189

To convert this into a tax code, the final digit is ignored. The PAYE code for the occupational pension would be 518P. (The ‘P’ indicates that the taxpayer is aged between 65 and 74 and is expected to have a total income of under £25,400 in the year to 5 April 2013).

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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