Your SIPP – An Income Tax Guide

Living abroad as a British expat comes with its own set of challenges, and one often overlooked aspect is managing your Self Invested Personal Pension (SIPP) effectively amidst changing regulations and tax laws. Staying on top of how your pension works and any shifts in legislation is not just a matter of convenience; it's a necessity for safeguarding your financial future.

Carla Smart, Group Head of Pensions & Chartered Financial Planner at Skybound Wealth, examines the intricacies of drawing an income from your SIPP and how to mitigate your tax liability in the process.

Much like when you are employed, the income you receive from your pension is taxed at source by HMRC under the Pay As You Earn (PAYE) system.  Due to the flexible nature in which pension income can be taken, HMRC must estimate how much tax to deduct each month. And at the end of the tax year in April, any over or under payment of tax can then be settled.

Tax-free cash

You have the ability to take 25% of the value of your pension free of tax at source. This can either be taken as a single lump sum or as a tax-free portion of a withdrawal. For example, if you took £4000 Uncrystallised Fund Pension Lump Sum (UFPLS) withdrawal, £1000 of this would be tax-free and £3000 would be liable for income tax. Please note that the tax-free allowance is capped at £268,275*.

*Unless protections are already in place.

The taxable element

The remaining 75% of the value of your pension is subject to tax, this is allocated to drawdown and can either be taken immediately as income or can be deferred and paid as income in the future.

How much tax do I pay?

The tax deducted will be determined based on how much of your taxable income is above your personal allowance, it will also depend on your PAYE tax code, how much you request and when this is taken in the tax year.

When you first request an income payment from the scheme, you will be taxed using the standard tax code (unless the ceding scheme has provided a P45 & tax code) Any overpayment of tax will need to be reclaimed directly from HMRC.  

any pension income you request from your SIPP may affect the tax rate that is applied to any other UK sourced income you receive.

What if I am overseas when I draw income from my UK pension?

As this is a UK pension, the pension income is taxable under UK rules. You may be subject to tax in your country of residence, so I would always recommend that you seek advice from a local tax specialist before making any withdrawals.

If you are tax resident in a country that has a Double Taxation agreement with the UK, HMRC may issue an NT tax code, which would mean no tax is deducted from your pension income (because you are exempt from UK income tax due to the double taxation agreement). In order to apply for an NT tax code, you must complete the relevant application form and submit this directly to HMRC.

HMRC have country specific forms for those tax resident in the following countries –

• Australia
• Canada
• France
• Germany
• Ireland
• Japan
• Netherlands
• New Zealand
• South Africa
• Spain
• Sweden
• Switzerland
• United States of America

If you live elsewhere, then you can use the standard claim form.  Skybound Wealth’s specialist pension division are on hand should you need any assistance in finding and/or completing the relevant form.

Your tax code:

Your SIPP provider will receive a tax code from HMRC which reflects your personal tax position. This code will enable your pension provider payroll system to determine how much tax to deduct from each payment.  To arrive at the appropriate tax code, HMRC will take all sources of income into consideration including employment income, savings interest, investments, and other pension income.

If your circumstances change throughout the year, please be aware that your tax code may also change. For example, if you begin to receive your state pension or drawdown from another pension – this may trigger a change in your tax code.

It is your responsibility to check that the tax has been calculated using the correct information – your SIPP provider will always inform you which tax code was used for any taxable payment that was made.

What tax code will your SIPP provider use?

• If they do not hold a tax code for you, they will use a standard tax code. They will then notify HMRC when any payments are made and HMRC will update the provider with the tax code that should be used moving forwards.
• If they receive a P45 from your previous pension provider for the same tax year, they will use the tax code on the P45.
• If the scheme already holds a tax code, they will continue to apply this unless told otherwise by HMRC.

Understanding your tax bill

The tax year runs from the 6th April to the 5th April each year and within that year, there are 12 tax periods running from the 6th to the 5th each month.

The tax you pay is dependent upon three key factors –

• Your individual tax code.
• The payment frequency of income drawdown.
• The tax period you pay in.

HMRC will then use this information to determine whether you should be taxed on a week 1 / month 1 basis or on a cumulative basis.

Week 1 / Month 1 basis –

If your tax code has W1/M1 at the end of it, then it will be calculated on a month 1 basis. HMRC will simply look at each payment you receive and then calculate your tax based on that payment alone. Your personal allowance will be included in the calculation but will be proportional to the chosen frequency of the payment – the same applies to the calculation of the tax bands.

Cumulative basis –

If you do not have an M1 at the end of your tax code, this means that you will be taxed on a cumulative basis. Every time you receive a payment, the tax that is calculated will consider how much of your personal allowance and income tax bands have been used already and what tax has been paid to date within that tax year.

How do I claim back any tax that has been overpaid?

Since the income tax deducted from pension payments paid through PAYE is an estimate of the tax that should be paid, the amount taken may be incorrect. If you have overpaid tax in a given tax year, a refund of the additional tax paid would only be possible if you request another income payment in the same tax year and the scheme have a cumulative tax code to use.

You will need to reclaim the tax directly from HMRC if you are not expecting to request / receive another payment in the same tax year. HMRC would then review your liability after the tax year has finished (5th April) and provide a tax calculation detailing any over / underpayments.

It is possible to reclaim tax back sooner – for this, you will need to contact HMRC for an in-year tax refund.

The relevant form to complete will depend on your circumstances –

• P50Z form – If you have withdrawn your entire pension and have no other income.
• 53Z form – If you have withdrawn your entire pension and have other sources of income.
• P55 form – If you have not withdrawn your entire pension and won’t withdraw further pension income in the current tax year.

You can claim your tax refund here.

Alternatively, Skybound Wealth’s specialist pension advisory team is on hand to assist you. Click the button below to book a complimentary consultation now.