The state retirement pension is taxable but it is paid without tax being deducted. The amount of your state pension should be set against your personal allowance in your PAYE code. However, this adjustment to the PAYE code was not done by the PAYE computer for state retirement pensions that commenced in the tax year 2010/11.

Any pensions paid by your former employer, or as an annuity from a personal pension plan, are taxed under PAYE. Where the state pension has been set-off against your personal allowance in your PAYE code, any balance of your personal allowance is used against your occupational pension leaving the rest of your occupational pension to be taxed at your marginal rate. Where your state pension has not been included in your PAYE code, all of your tax free personal allowance will be set against your occupational pension and not enough tax will be deducted from that income under PAYE.

If you are in this position you will receive a PAYE reconciliation (form P800), at some time in the next 12 months, which will show you how much tax was deducted under PAYE and how much should have been deducted. If the difference is less than £2,000, the tax due will be collected through your PAYE code in the three years to 2013/14. However, where the amount owing is £2,000 or more the Tax Office may demand payment immediately. You should resist this, and ask for the tax due to be collected through your PAYE codes, as the tax underpayment is purely due to a Tax Office mistake.

This is not the first time the PAYE computer has made this error. Up to 250,000 pensioners had an incorrect amount of their state pension included in their PAYE codes for the tax years 2008/09 and 2009/10. In these cases the Taxman decided not to collect the underpaid tax and the pensioners were not informed of the mistake.

Neil Harries tax editor and director at Bridgend Accountants Harries Watkins Jones.

The author does not guarantee the accuracy of any information provided in this article and recommends that you do not take any action, whatsoever, based on the information provided. By the fullest extent permitted by law, the author does not accept any responsibility for any actions you may or may not take based on information contained in this article. This article contains general information and is not a substitute for specific independent professional advice. In addition it is emphasised that much of the information provided in this article is time sensitive and information contained within it may be out of date.