Know your choices at retirement
Understand annuities, drawdown, and lump sums - and how to combine them for a suitable retirement income plan.
1 Nov 2024 | 7 min read
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Pension taxation
Understand how pension withdrawals are taxed, what counts as tax-free cash, and how better planning can help you keep more of your retirement income.
Tax relief on contributions
When you contribute to your pension, the government tops it up with tax relief at your marginal rate. If you are a basic-rate (20%) taxpayer, every £80 you contribute becomes £100 in your pension. Higher and additional-rate taxpayers can claim even more through their self-assessment return.
This relief can make pension contributions tax-efficient. For higher earners, the effective cost of contributing can be reduced, but allowances and personal tax position should be checked before acting.
Government tops up every contribution with relief at your marginal rate
Basic-rate taxpayers turn every £80 into £100 in their pension
Higher earners can reclaim additional relief via self-assessment
Take up to 25% of your pot entirely tax-free capped at £268,275
Phase withdrawals over time no need to take it all at once
Large lump sums in one year can push you into a higher tax bracket
Tax-free cash lump sum
When you first access your pension, you are typically entitled to take up to 25% of your pot as a tax-free lump sum known formally as your Pension Commencement Lump Sum (PCLS). This is capped at £268,275 across all your pensions combined. You do not have to take it all at once you can phase it over time.
Eligibility and how this works in practice depends on your scheme type. Most defined contribution (DC) pensions let you take the 25% freely once you reach the minimum pension age. Defined benefit (DB) schemes usually calculate your lump sum differently often by giving up some of your guaranteed pension income in exchange for cash so it is worth checking the terms of your specific scheme.
Timing this correctly matters. Taking a large lump sum in a single tax year can push other income into a higher bracket. A regulated adviser can model when and how to take your tax-free cash in a way that fits your circumstances.
Income tax in retirement
All pension income beyond the tax-free cash is taxed as regular income. You still receive a personal allowance (currently £12,570 per year), so you pay no tax on income below this threshold. The state pension counts toward this total.
Planning the order and size of your withdrawals can affect your tax position. Spreading income across tax years, or blending pension income with other sources, may help you stay within lower tax bands.
£12,570 personal allowance no tax on income below this threshold
Spread withdrawals across tax years to reduce your lifetime tax bill
Blend pension income with other sources to stay in lower tax bands
Contribute up to £60,000 per year with full tax relief
Carry forward unused allowance from the previous three tax years
Exceeding the allowance results in a tax charge on the excess
The annual allowance
The annual allowance limits how much can be contributed to your pensions in a single tax year while still receiving tax relief. The standard allowance is £60,000 (or 100% of your earnings, whichever is lower). Going over this limit results in a tax charge.
If you have not used your full allowance in the previous three tax years, you may be able to carry forward the unused amount. This is particularly useful for those with variable income or those who want to make a large one-off contribution.
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Tax positions vary significantly. Our advisers will look at your specific circumstances and help you build a tax-efficient retirement strategy.
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FAQs
Common questions about pension tax
Reviewed for accuracy: . This guide is general information, not a personal recommendation. Pension and tax rules can change, and suitability depends on your circumstances.