Pensions and tax

Steve has £15,000 in his Nest pension pot. He decides to withdraw the whole amount when he reaches 65.

As we don’t have Steve’s tax code, we follow HMRC guidelines and use an emergency tax code - for example, 1250L - to calculate how much tax to deduct.

As 25% isn't taxed, Steve can receive £3,750 as a tax-free lump sum.

£15,000 x 25% = £3,750

We apply the emergency tax code to the remaining £11,250. The tax-free personal allowance under this code is £12,500 per year, which works out to £1,042 personal allowance each month.

As Steve is taking his pension in one lump sum, he can withdraw a further £1,042 tax free.

£15,000 - £3,750 - £1,042 = £10,208

That leaves £10,208 taxed at the basic rate of 20%.

£10,208 x 20% = £2,041.60

This means Nest will deduct £2,041.60 from the £15,000 withdrawal, meaning that Steve receives £12,958.40.

£15,000 - £2,041.60 = £12,958.40

Joanne has a pot of £20,000. She decides to start making regular withdrawals of £400 per month to supplement the State Pension and her part-time earnings as she has semi-retired.

As Nest doesn’t have Joanne’s tax code when the first payment is made, we follow HMRC guidelines and use the emergency tax code to calculate how much tax to deduct.

As 25% is taken as a tax-free lump sum, Joanne receives £100 out of her £400 withdrawal. 25% tax-free allowance of £400 = £100.

We apply emergency tax to the remaining £300. The tax-free personal allowance under this code is £12,500 over the course of 12 months, which works out to £1,042 each month.

As Joanne’s withdrawal is less than £1,042, we don’t deduct any tax. Joanne will receive the full £400.

By the time the second withdrawal is made Nest has received Joanne’s actual tax code from HMRC, which is 123L. The new tax code reflects other income Joanne has, including the State Pension. The second £400 withdrawal therefore has a different amount of tax deducted from it. The gov.uk website provides information on how HMRC issues tax codes.

As 25% is taken as a tax-free lump sum, Joanne receives £100 out of her £400 withdrawal. 25% tax-free allowance of £400 = £100.

We apply the correct 123L tax code to the remaining £300. The tax-free personal allowance under this code is £1,230 per year, which works out to £102.50 each month.

This means a further £102.50 can be withdrawn with no tax payable.

£400 - £100 - £102.50 = £197.50

So £197.50 will be taxable at the basic rate of 20%.

£197.50 x 20% = £39.50

This means Nest will deduct £39.50 from the £400 withdrawal, meaning Joanne receives £360.50.

Your annual allowance is the most you can save in your pension pots in a tax year before you have to pay tax on your pension contributions. You may have to pay tax if you go over the annual allowance, which is currently £60,000 per year. If you take money out of your Nest pension pot then your annual allowance may be reduced to £10,000 per year. If you contribute over £10,000 to any pension schemes in a single year after your allowance is reduced, you may have to pay a tax charge on the amount that exceeds the limit. This restriction may not apply if you’re withdrawing your Nest pension pot completely and its value is less than £10,000. We’ll let you know whether this is the case when you request the withdrawal.

Usually, you can take the first 25% of your pot tax-free. The remaining 75% is taxable in the same way as any income, like your wages. The total tax-free amount you can take from all your pension pots is £268,275. Any lump sum you take over this will be taxed at your marginal rate of income tax.

Although we try to deduct the right amount of tax, we might not have all the information we need, like your current tax code from HMRC. It’s possible that you’ll need to pay more tax or have some tax refunded. If you think you should get a refund you can claim this directly from HMRC.

If you think you’ve paid too much tax or believe you need to pay more, you don’t have to wait until the end of the tax year for the adjustments to be made. You can send a form to your local tax office for an immediate assessment. The form you need to complete depends on your circumstances. You can find the right form for you on the HMRC website.

If you die before turning 75 and we pay your pension pot to your beneficiaries or estate within two years, it’ll normally be paid tax-free.