EIM75010 - The taxation of pension income: pension income: essential principles

What is pension income?
Pensions in non-cash form
Amount of pension income charged to tax
Person who is liable to tax
Paying tax
Effect of residence

What is pension income?

Part 9 ITEPA 2003

This section of the manual relates to payments chargeable to tax as pension income under Part 9 ITEPA 2003.

Pension income can arise from various sources, including:

  • State Pension (social security payments)
  • registered pension schemes
  • employment-related pensions and annuities
  • personal pensions
  • foreign pension arrangements
  • certain lump sums taxable as pension income

Pension

A pension is a periodical payment that usually arises from provisions made by or on behalf of an individual an employer or from the government. Depending on the contract or scheme rules, it could be paid to the pension scheme member or to a beneficiary after the member’s death.

Voluntary pensions are also chargeable to tax (see EIM75800).

Annuities

An annuity is a periodical payment, expressed as an annual amount, whether made under an obligation or voluntarily.

Certain annuities are charged to tax as pension income (see EIM75300) by Part 9 ITEPA 2003. Other annuities are chargeable as Savings and Investment Income – see SAIM1060.

Lump sums

Lump sums do not have the character of periodical payments and so are not considered pensions. However, some lump sums and income withdrawal arrangements are taxable as pension income. The relevant page of guidance for each source of pension income explains when a lump sum is taxable.

Pensions in non-cash form

Pensions are usually paid in cash, or expressed as a monetary amount, so there is no problem with identifying the amount receivable. However, in some cases a former employer may meet the pecuniary liability of a pensioner or provide benefits in kind. These arrangements are unlikely to be under a registered pension scheme (as the payment would usually be taxable as an unauthorised payment). However, the arrangement may constitute a separate scheme that is an ‘employer-financed retirement benefits scheme’ (EFRBS). See EIM15020 for guidance on what an EFRBS is and on the tax treatment of non-cash benefits provided under an EFRBS.

The legislation about benefits of employees or directors does not apply to Part 9 ITEPA 2003 (pension income). Liability to tax may be considered under:

  • section 569 – taking the view that the provision is a voluntary pension
  • section 633 – on the basis that the provision is a voluntary annual payment

There is a higher probability that the provision will be chargeable as pension income where there is a series of payments.

Amount of pension income charged to tax

Sections 567 and 638 to 654 ITEPA 2003

For each pension or annuity, the amount charged to tax is the ‘net taxable pension income’ for the tax year. This is the amount of taxable pension income less any deductions allowed from pension income.

The page of guidance for each type of pension income explains how to calculate the amount of taxable income for that type of pension or annuity.

Most types of pension income are taxable as the pension accrues rather than when it is received. EIM75020 provides more information about the accrual basis and its effect in relation to arrears or advance payments of pension income.

Pensioners are often content to pay Income Tax on the amount received in a year, as in most years the amounts accruing and received are similar. However, it is possible in certain circumstances for the amounts to be different. If a taxpayer requests the statutory basis this should be accepted.

Deductions

Section 567(5) ITEPA 2003

The only deductions that can be applied against an amount of pension income are:

  • sums withheld by a pension provider as a donation to charity through payroll (Part 12 ITEPA 2003)
  • a deduction to avoid double taxation where Part 7A ITEPA (employment income provided through third parties) has applied to the source of the pension income
  • a 10% deduction for payments from certain overseas government pensions – see EIM75500 (note this deduction is already applied in arriving at the taxable amount of this type of pension income)

Exemptions

Some types of pension are not subject to Income Tax. These include certain:

  • pensions paid following the death of a member of a registered pension scheme – see EIM75600
  • pensions or annuities paid in respect of awards for bravery – see EIM75920
  • pensions payable in respect of service in the Armed Forces – see EIM75920
  • disability pensions – see EIM75080
  • health and employment insurance pensions – see EIM75080
  • pensions payable to non-UK residents – see EIM75080

This is not a complete list. EIM75080 provides guidance on the types of pension that may be exempt from tax.

Person who is liable to tax

In general, the person liable to tax on the pension income is the person who receives or is entitled to it.

See EIM75050 for guidance on who is liable to tax where entitlement to a pension is included as part of a financial settlement on divorce.

Paying tax

In most circumstances, pension income is usually subject to deduction of tax under PAYE, so the payer usually deducts tax before paying the remainder to the pensioner. The page of guidance for each type of pension income explains if PAYE should be operated.

Effect of residence

Whether the residence status of a pension recipient affects their liability to tax depends on the type of pension income. For example, pension income from a registered pension scheme (whether established in the UK or outside the UK) is taxable regardless of the residence of the recipient, but other foreign pensions are taxable only when they are paid to UK residents.

Pensions payable to non-UK residents are also exempt from tax in some circumstances – see EIM75080.

A double taxation agreement might apply to alter the taxing rights of either the country of residence of the pension payer or the country of residence of the pension recipient. EIM75070 provides more information.

If UK tax charges are reduced because the pension recipient has been non-UK resident for a temporary period, the pension income may be brought into charge in the period of return to the UK. EIM75450 provides more information about this.