Final salary/defined benefit pensions
Defined benefit pensions are offered by some employers and provide a guaranteed retirement income based on your salary and years of service. They are often referred to as gold-plated pensions.
Contributions - your pension contributions receive tax relief in the same way as defined contribution schemes. Your employer may also contribute on your behalf.
Growth - unlike defined contribution schemes, you do not need to worry about growth. A defined benefit pension promises to pay you a guaranteed income for life from a set age, regardless of how the underlying investments have performed.
Tax-free cash - some defined benefit schemes allow you to take a tax-free cash sum. However, this generally has to be at the point you start receiving your guaranteed income, which will go down in value because of the tax-free lump sum you have taken.
Income - the guaranteed income paid by your defined benefit pension scheme is taxed as regular income under PAYE, but you will not pay National Insurance on it. It is not taxable if it falls below your personal allowance.
Death before 75 - rules for defined benefit schemes are much stricter than with defined contribution schemes. In many cases, when you die a proportion of that guaranteed income will continue to be paid to your spouse or partner, or sometimes a dependent. This income will be taxed as earnings at their marginal rate. In some cases, if the value of the pension is small and if you die while an active member of your defined benefit pension scheme, your beneficiary might be able to withdraw the funds as a tax-free lump sum. Rules vary from scheme to scheme. So, it is important to speak with your pension provider to understand the specific rules that apply to you.
Death after 75 - if you die after 75, income tax is due on death benefits whether they are taken as a lump sum or income.
In summary, the tax treatment of pensions in the UK is designed to provide significant incentives to save for retirement. To understand the taxation of overseas pensions you should consult with your pension provider. If you are looking to transfer your overseas pension it is highly recommended that you seek advice from a regulated financial adviser.
In summary, defined benefit pensions enjoy significant tax advantages, with tax relief on contributions and tax-free growth. The key difference between defined benefit and defined contribution pensions is the guaranteed income, which brings long-term security.
The State Pension
The State Pension is a weekly income provided by the government once you reach State Pension age, and the amount your State Pension is worth is dependent on your National Insurance record. If you reached State Pension age before 6 April 2016, the amount you get will be dependent on the basic State Pension rules. Everyone else falls under the new State Pension rules.
Contributions - you build up entitlement to the State Pension through your National Insurance contributions during working life. These contributions are made with pre-tax income.
Income - the State Pension is taxable income, but most people have an income low enough to fall under the tax-free personal allowance. However, if your total income including the State Pension exceeds certain thresholds, part of your State Pension may become taxable. For example, if you are receiving a workplace pension and State Pension, and the total value of your income exceeds your tax-free personal allowance, you will be taxed at your marginal income rate.
Death - State Pension payments stop when you die, and it only provides an income for the pension recipient. There is no death benefit value to pass on. If you qualify for the Additional State Pension, then your partner may be able to inherit some of this when you die.
Unfunded public sector pensions
Special unfunded public sector pension schemes exist for nurses, teachers, police officers, civil servants, etc. These provide a guaranteed retirement income.
Contributions - you receive tax relief on any employee pension contributions you make to the unfunded public sector scheme.
Growth - as with other pensions, the invested funds grow free of UK income and capital gains tax. However, as with standard defined benefit schemes, the income you receive is guaranteed regardless of the performance of the underlying investments.
Income - the guaranteed income you receive is taxed under PAYE as regular salary income at your marginal income tax rate.
Death before 75 - pension death benefits can typically be paid tax-free to your nominees if you die before age 75. It is important to check with your provider what their particular rules are.
Death after 75 - If you die over age 75, death benefits taken by beneficiaries are taxed as income at their marginal rate.
Overseas pensions
If you have paid into overseas pensions while working abroad, the tax treatment depends on the country and scheme rules.
Contributions - you may be able to claim UK tax relief on contributions to certain qualifying overseas schemes.
Income - income is taxed according to the country you are resident in when taking benefits. Double taxation agreements sometimes apply.
Transfers - moving pensions to/from overseas schemes has complex tax implications. It is important to seek professional regulated advice.
In summary, defined contribution pensions, like personal and most modern workplace pensions, receive favourable tax treatment to encourage pension savings. Tax relief goes in, no tax is paid on growth, and just income tax due on withdrawals. Even then, up to 25% can be taken tax-free.
In summary, the tax treatment of pensions in the UK is designed to provide significant incentives to save for retirement. To understand the taxation of overseas pensions you should consult with your pension provider. If you are looking to transfer your overseas pension it is highly recommended that you seek advice from a regulated financial adviser.
Below we outline the fundamentals of pension taxation to help you to better understand your pension options.
