Pension tax codes and their meanings
There is a lot of confusion from clients when they start taking their pension income. Due to Pension Freedoms people are accessing their pensions in different ways rather than the traditional Annuity route. If you have multiple income streams from different employers and pension providers then each one will have a different tax code to use in calculating the tax you pay.
On receipt of a pension income request for the first time Hartley is required to apply a tax code to the client so that income tax can be paid.
The first task is for Hartley to apply a tax code. If you have left employment in this tax year then we can accept your P45. This will contain a tax code that we can use. If you have already given this tax code to a new employer or to another pension provider then we can not use this tax code. If you do not have a tax code that we can use then you will need to complete a new starter form. It can be found here
The language used is aimed at employees but it is the correct version. HMRC do not use language aimed at pension income but instead treat everyone as an employee of a company.
The information provided on this form will allow us to use a temporary tax code. This will be used to calculate the tax on your first income payment. HMRC will use all of the information provided to check their records and send us a new tax code if the one we have used should be altered.
HMRC run on the basis that tax should never be under paid but they might need to refund!
HMRC treat pensions income as the same as an income that you would receive in employment but you do not pay National Insurance contributions on pension income received. You will pay income tax based on your tax code.
What does the tax code mean?
When it comes to Tax codes they normally start with a number and end with a letter. The numbers in an individual’s tax code show how much tax-free income they get in that tax year. You usually multiply the number in the tax code by 10 to get the total amount of income they can earn before being taxed.
For example, an individual with the tax code 1150L can earn £11,500 before being taxed. If they earn £27,000 per year, their taxable income is £15,500.
The letters in an individual’s tax code refer to their situation and how it affects their Personal Allowance.
| Code | How tax is deducted | When this code is usually used |
|---|---|---|
| 0T | From all income - there is no Personal Allowance | When an employee hasn’t given you a P45 or enough details to work out their tax code, or when their Personal Allowance has been used up |
| BR | From all income at the basic rate | For a second job or pension |
| D0 | From all income at the higher rate | For a second job or pension |
| D1 | From all income at the additional rate | For a second job or pension |
| L | At basic, higher and additional rates depending on the amount of taxable income | For an employee entitled to the standard tax-free Personal Allowance |
| M | At basic, higher and additional rates depending on the amount of taxable income | For an employee whose spouse or civil partner has transferred some of their Personal Allowance |
| N | At basic, higher and additional rates depending on the amount of taxable income | For an employee who has transferred some of their Personal Allowance to their spouse or civil partner |
| NT | No tax is deducted | Very specific cases, for example musicians who are regarded as self-employed and not subject to PAYE |
| S | At the rates in Scotland | For an employee whose main home is in Scotland. It’s their responsibility to tell HM Revenue and Customs (HMRC) if they change address |
| T | At basic, higher and additional rates depending on the amount of taxable income | When HMRC needs to review some items with the employee |
W1 (week 1) and M1 (month 1) are emergency tax codes and appear at the end of an individual’s tax code, for example ‘577L W1’ or ‘577L M1’. Tax is calculated only on what they are paid in the current pay period, not the whole year.
The letter K is used in an individual’s tax code when deductions due for company benefits, state pension or tax owed from previous years are greater than their Personal Allowance.
Multiply the number in their tax code by 10 to show how much should be added to their taxable income before deductions are calculated.
For example, An employee with tax code K475 and a salary of £27,000 has taxable income of £31,750 (£27,000 plus £4,750).
The tax deduction for each pay period can’t be more than half an individual’s pre-tax pay or pension.
