How tax codes work

How tax codes work

As explained in the previous section (on pensions) 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 and yet cannot be taxed directly. Any other pensions or employment income would then usually be given  a BR PAYE tax code (= basic rate, i.e. 20% tax deducted).

The 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 £24,000 (in 2011/12). If your income is above this figure, then your ‘age related’ atx free personal allowance is reduced (see the Personal allowance section).

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 2012. He also has an occupational pension of £11,000 pa. As he is over 65, he is entitled to tax free pay of £9,940 in the tax year 20011/12.

Tax free pay due                                                                                            9,940

Estimated state pension                                                                                5,311

Tax free pay remaining for occupational pension                                        4,629

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 is aged between 65 and 74 and is expected to have a total income of under £24,000 in the year to 5 April 2012).

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.