Taxation of retirement benefits and pensions
Traditional income tax must be paid on retirement benefits or pension payments and the tax is deducted from monthly payments. If you receive a salary or pension from other bodies than LSR, you need to assess which payer should use the personal tax credit and in which tax bracket the fund's payments should be taxed.
You are responsible for notifying the fund in which tax bracket retirement benefits or pension payments should be taxed, and whether the personal tax credit should be used. In this way, you prevent tax payments from being either over- or under-calculated, which can lead to inconvenience later.
If the spouse does not fully use their personal tax credit, retirement benefits recipients and pensioners can use up to 100% of the spouse's unused personal tax credit.
You can check your status on the Iceland Revenue and Custom’s service pages, where you can see information about tax brackets and the use of personal tax credit. You can also contact the fund for further advice regarding tax brackets.
There are three monthly tax brackets plus the tax-free limit:
- Income under ISK 446,136 (31.48%)
- Income from ISK 446,137 to 1,252,501 (37.98%)
- Income over ISK 1,252,501 (46.28%)
- Tax-free limit: ISK 206,245 based on 100% utilisation of personal tax credit
What is the best way to decide on a tax bracket and utilisation of personal tax credit.
Everyone's situation is different, but the following guidelines are good to keep in mind:
Who usually pays you the highest taxable payment per month?
If LSR pays the highest payment
- Let LSR take full advantage of the personal tax credit and select tax bracket 1. Then all payments from LSR go to the correct tax bracket.
- If you receive payments from other parties, let them know how much LSR payments are usually before tax, so they can put their payments in the correct tax bracket.
- If the payment from LSR is lower than the tax-free limit, you can let other employers or pension funds use the remaining personal tax credit each month.
If another party pays the highest payment:
- Let the party in question make full use of the personal tax credit and use tax bracket 1.
- If you anticipate that LSR payments will only fall under one specific tax bracket when they overlap with payments from others, select the relevant tax bracket for LSR payments.
- If you anticipate that the LSR payments will fall into two different tax brackets, however, select the option "Tax bracket should be based on my other monthly income" and record the income you have with someone other than the LSR. Then LSR taxes its payments correctly in the appropriate tax bracket.
- If the relevant party does not fully use your personal tax credit, you can let LSR use the remaining part.
Examples of choosing tax brackets
Example 1: Lára receives payments from four pension funds
- Fund 1: ISK 420,000 per month
- Fund 2: ISK 150,000 per month
- Fund 3: ISK 70,000 per month
- Fund 4: ISK 25,000 per month
Payments from funds 1 and 4 are close to the maximum in tax bracket 1 (see more on tax brackets above). Therefore, it is best for Lára to put payments from fund 1 and 4 in tax bracket 1 to fully utilise it. She would also ask fund 1 to use her personal tax credit. Then Lára would ask funds 2 and 3 to place their payments in tax bracket 2.
Example 2: Gunnar receives payments from his employer and LSR
- Employer: ISK 350,000 per month
- LSR: ISK 250,000 per month
Since the employer's payments do not fully utilise tax bracket 1, but are higher than LSR's payments, it makes the most sense for Gunnar to have the employer fully utilise his personal tax credit and use tax bracket 1. At LSR, he should then select "Tax bracket shall be based on my other monthly income" and then enter 350,000 in the field. Then LSR uses tax bracket 1 for income from ISK 350,000 and up to the next tax bracket, and then tax bracket 2 after that.
Residency abroad
Retirees and pensioners who live in a country that has a double taxation agreement with Iceland can apply for an exemption from taxation of pension income. This is done by filling out a special form at Iceland Revenue and sending it along with the necessary supporting documents. If Iceland Revenue agrees that LSR's pension payments are exempt from taxation in Iceland, LSR will be notified of this. Note that the exemption is only valid for one year at a time and must therefore be applied for annually.