I don’t really understand how social welfare payments are taxed. Can you explain?
AnswerIf you have a social welfare payment and another source of income, you may have to pay tax on your combined income. Some social welfare payments are not taxable, but most long-term payments, such as old age pensions or widowed people’s pensions are. Illness Benefit and Invalidity Pension are also taxable.
Your taxable social welfare payment and your other income are added together. You are taxed on the total amount. There is no mechanism for taxing your social welfare pension at source (before it is paid to you). Your other income determines how tax due is paid.
For example, you are getting a State Pension (Contributory) and an occupational pension. Your occupational pension is taxed through the PAYE system in the same way as a wage or salary. This means that you get your tax credits in the normal way.
In order to tax your social welfare pension, your annual tax credits are reduced by the tax liability on your social welfare pension. You then effectively pay tax on both the pensions, but it is collected from the occupational pension. For higher incomes, the standard rate cut-off point will also be reduced. The technical term for this is coding-in of credits. The same arrangement applies if you have income from a job as well as a social welfare pension.
If your social welfare pension was not coded in, you would have to pay tax as a self-employed person and in a lump sum by 31 October each year.
If your other source of income is not taxed on the PAYE system, for example, you have investment income or you have an occupational pension from abroad, then you are classed as a self-employed person and your tax is payable annually by self-assessment, due by 31 October each year.