I reached state retirement age in March 2016 but deferred receiving my state pension for 12 months. I have been informed that I can now take a lump sum in addition to my regular state pension. Is the lump sum taxable?
The lump sum is taxed as income. In simple terms, the rate of tax that applies to the lump sum will be the highest rate that applies to your other income for that tax year. This means that:
– if you are not liable to tax for that tax year on your other income, ignoring any deductions from that income for the marriage allowance or married couple’s allowance, no tax should be deducted from any state pension lump sum you receive;
– if you are liable to income tax, you will pay tax at one of the following rates: – 20% – where taxable income does not exceed the basic rate limit (£33,500 for 2017/18);
– 40% – where taxable income exceeds the basic rate limit but does not exceed the additional rate limit of £150,000; or
– 45% – where taxable income is over £150,000.
When working out what rate of tax you should pay on any state pension lump sum, the special rates that are used to tax savings income and dividend income falling within the basic rate band – the 0% starting rate for savings, savings and dividend nil rates (personal savings and dividend allowances), are ignored. So if all your other income falls within the basic rate band of tax, you will pay tax at 20% on your state pension lump sum.
Similarly if you are a higher rate taxpayer, you will pay tax at the rate of 40% on your state pension lump sum. This will also be the case if you have dividend income that is chargeable to tax at the rate of 32.5%.
If you are an additional rate taxpayer, that is, you pay income tax at the rate of 45% (or 38.1% on dividends), you will pay tax at the rate of 45% on your state pension lump sum.