If you receive the State Pension or other state benefits, these are paid to you without tax being deducted.  If you are working or you receive a company, public sector or personal pension where the tax is deducted using the Pay as you Earn (PAYE) system then you will ordinarily pay tax on your state pension and state benefits through the same system.

In order to pay tax on your state pension or state benefits income, your tax code will generally be altered to take these earnings into account.  Our guide looks at how this is done.

How your tax code deals with state pension or state benefit income

Even though your state pension and other state benefits are taxable, they are paid to you without any tax being deducted.  So, to claim this tax, HM Revenue and Customs will normally ask your company, public sector or personal pension provider to collect any tax due on your state pension or benefits.

The way that this is done is by your tax code being adjusted to take into account your state pension/benefit income.

If you are employed and receiving the state pension or another benefit, either your employer will be asked to collect the tax due on your state pension/benefits through the PAYE system or it will be collected through your company/personal/public sector pension provider’s PAYE system.

A tax code will be issued to your pension provider or employer telling them how much tax should be taken off.

How your tax code is altered to take a state pension/state benefits into account

In order to claim the tax that you owe on your state pension or benefits, HM Revenue and Customs alter your Personal Allowance in your tax code by taking off the amount of state pension or benefits that you receive.  This is in addition to any adjustments that are made to take other allowances or deductions into account.

Whatever figure is left is the amount of tax free income that you can earn in the current tax year.  This amount is then deducted from your company/public sector/personal pension (or from your employment income) and you pay income tax on what is left.

Example for 2011/12 tax year

You’re 68, have retired and get a company pension of £7,000 and a State Pension of £5,577.  As your total income is below £24,000, you’re entitled to the full age-related Personal Allowance for your age-group.

Your tax code is adjusted to collect the tax due on your State Pension out of your company pension as follows:

• Your Personal Allowance for the 2011/12 tax year based on your age is £9,940
• Your state pension of £5,577 is deducted (as you should be paying tax on this amount) leaving you with a Personal Allowance of £4,363
• Your tax code will be 436P – 436 is the amount of your Personal Allowance with the last number taken off whilst P means that you’re entitled for the full age related Personal Allowance
• HM Revenue and Customs subtracts the balance of your Personal Allowance from your pension (£7,000 – £4,363 = £2,637) and the amount of company pension that you pay tax on is £2,637