Planning for your retirement is not just about saving enough money; it’s about understanding exactly how and when your pension will be taxed. Without proper tax planning, you could end up paying more than necessary, reducing the income you have available to enjoy the retirement lifestyle you want. Many people assume that pensions are automatically tax-free, but in reality, most pension withdrawals are subject to income tax. However, with careful planning and the right advice, you can optimise your pension income and minimise your tax liabilities.
This guide breaks down how pensions are taxed in the UK, provides strategies for tax efficiency, and explains how to calculate what tax you might pay on your pension.
Quick summary: minimise tax on your pension
Most pension income is taxable, but smart planning can reduce your tax bill. Short on time? Here’s the essential info you need to know:
- Spread withdrawals across multiple tax years to stay in lower tax bands.
- Take tax-free lump sums in stages rather than all at once.
- Use tax-efficient savings, like ISAs, to supplement income.
- Plan rental and part-time income carefully to stay within tax-free allowances.
Do you pay tax on your pension?
Yes, most pensions are subject to income tax. While the government allows a portion of your pension to be withdrawn tax-free, the remaining amount is treated as taxable income.
The amount of tax you pay depends on your total income in retirement, including any other sources such as personal and workplace pensions, savings interest, rental income, or part-time earnings.
The key to minimising your tax liability is understanding which parts of your pension are taxable and structuring withdrawals strategically to stay within lower tax brackets.
How are pensions taxed?
Tax on your State Pension
- Taxable Income: The State Pension is considered taxable income but is paid without tax deducted at source.
- Personal Allowance: The Personal Allowance threshold has been frozen at £12,570 until 2029. If your total income, including the State Pension, exceeds this allowance, you will owe tax on the amount over £12,570.
- The triple lock policy: This ensures that the UK State Pension increases each year by the highest of inflation (CPI), average earnings growth, or 2.5%. This protects pensioners’ income from losing value due to rising living costs. However, since the Personal Allowance is frozen until 2029, these increases could push more pensioners over the tax-free threshold, making a larger portion of their State Pension taxable.
- Tax Collection: Since tax isn’t deducted from the State Pension directly, HM Revenue & Customs (HMRC) may adjust your tax code to collect the owed tax through other income sources, such as workplace pensions or employment income. If you’re not getting income from these sources, you’ll need to complete a self-assessment tax form each year and pay any applicable taxes directly to HMRC.
Tax on Your Personal Pension
- 25% Tax-Free Lump Sum: Upon reaching the minimum pension age (currently 55, rising to 57 from April 2028), you can withdraw up to 25% of your pension pot tax-free subject to the requirements of the Lump Sum Allowance (LSA). The LSA is the limit on the total amount of certain tax-free lump sums that you will be able to receive before marginal rate taxation applies. The limit is £268,275 but may be higher if you have a former Lifetime Allowance (LTA) protection.
- Taxable Withdrawals: Any withdrawals above the tax-free lump sum are added to your taxable income for the year and taxed at your marginal rate.
- Emergency Tax: Large, one-off withdrawals can trigger an emergency tax code, leading to higher tax deductions. You may need to reclaim any overpaid tax from HMRC.
How can I minimise taxation on my pension?
Income tax bands for pensions: strategies to stay in lower brackets
One of the most effective ways to minimise tax on your pension is to manage withdrawals strategically to keep your income within lower tax bands. In the UK, income tax is currently charged progressively on the following basis:
- Subject to having a full personal allowance for tax purposes, tthe first £12,570 is tax-free. This could be lower and will depend on your personal tax allowance.
- Income between £12,571–£50,270 is taxed at 20%,
- Income between £50,271–£125,140 is taxed at 40%,
- Income above £125,140 is taxed at 45%,
By spreading pension withdrawals across multiple tax years, you can avoid pushing your income into a higher tax bracket. For example, if you have flexibility over when to take withdrawals, you may choose to take smaller amounts each year rather than withdrawing a large lump sum all at once.
This approach can be particularly useful for those who are close to the threshold of a higher tax band.
Tax-free lump sums: how to withdraw them efficiently
Taking advantage of the 25% tax-free lump sum is a key tax-saving strategy. However, rather than taking it all in one go, it may be more tax-efficient to withdraw smaller tax-free sums over a number of years.
This can help you manage your taxable income while still benefiting from the tax-free allowance. For example, if you only need a portion of your lump sum immediately, you can leave the rest invested and take withdrawals as needed.
This phased approach can reduce the risk of unnecessarily increasing your taxable income in a single year.
Minimising tax on other retirement income
Many retirees have additional sources of income beyond their pensions, such as savings, rental income, or part-time work. It’s important to structure these sources of income efficiently to avoid excessive taxation. For example, savings held in Individual Savings Accounts (ISAs) allow for tax-free withdrawals, making them an ideal complement to pension income.
If you own rental properties, you may be able to offset some of your income with allowable expenses or consider transferring ownership to a lower-earning spouse to reduce overall tax liability. For those who work part-time in retirement, ensuring that earnings remain within the Personal Allowance can help prevent unnecessary tax payments.
How to calculate what tax you’ll pay on your pension
To estimate your pension tax liability, start by adding up all sources of income, including your State Pension, workplace and personal pensions, rental income and any taxable interest from savings.
Next, apply your Personal Allowance (which will be a maximum of £12,570 for the 2024/25 tax year), which is the amount you can earn before paying tax. If your total income exceeds this amount, the excess will be taxed based on the current income tax bands detailed above. If you want a precise estimate, you can use HMRC’s online tax calculator or seek advice from a financial professional.
Take control of your pension tax today
Understanding how your pension is taxed and planning your withdrawals carefully can significantly reduce your tax burden and increase your disposable income in retirement.
By spreading withdrawals over multiple years, taking tax-free lump sums in stages, and managing other income sources efficiently, you can optimise your pension income and avoid unnecessary tax payments. However, pension taxation can be complex, and getting it wrong could mean paying more tax than necessary.
At Flying Colours, we specialise in helping retirees structure their pension withdrawals in the most tax-efficient way. Our expert financial advisors can guide you through the complexities of pension taxation and help you make the most of your retirement income.
Get in touch today for personalised advice and take control of your retirement finances with confidence.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only. All information is correct at the time of writing and is subject to change in the future.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance. The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
