Guide to Tax and Pensions
Pensions are a core component of any retirement planning strategy.
They act as a regular source of income and help provide financial stability when we stop working.
However, pensions are not exempt from tax.
When it comes to planning for retirement, understanding pension tax implications is crucial. That way, you can make the most of your retirement savings.
This pension tax guide provides a comprehensive overview of the topic, covering important information to help you better understand tax in retirement.
Do you pay tax on pension income?
Once you reach the State Pension age, you no longer have to pay National Insurance contributions, even if you continue working.
However, you do still need to pay Income Tax.
Tax on income from pensions is calculated in the same way as earnings from employment.
Each UK tax year you have a Personal Allowance (currently £12,570). Any income, including pension income, above this is taxed.
The Income Tax bands are:
- Basic rate (£12,571 to £50,270) — 20%
- Higher rate (£50,271 to £125,140) — 40%
- Additional rate (over £125,140) — 45%
Additional rate taxpayers do not receive a Personal Allowance.
For up-to-date figures, see the UK government’s Income Tax rates and Personal Allowances.
What counts as taxable income?
You pay Income Tax on pension savings if your total annual income exceeds your Personal Allowance.
But your total annual income includes more than just your pension. According to the UK government, income could include:
- State Pension (basic or new State Pension)
- Private pensions — including workplace pensions and personal pensions
- Taxable state benefits
- Earnings from employment or self-employment
- Other income such as property, savings or investments
Tax on pension contributions
Pensions can be a tax-efficient way to save for retirement because contributions can receive tax relief.
With tax relief, some of the money you add that would otherwise have gone to the government as tax goes into your pension fund.
Relief usually matches your Income Tax band:
- Basic-rate taxpayers — 20%
- Higher-rate taxpayers — 40%
- Additional-rate taxpayers — 45%
You can receive relief on contributions up to 100% of your annual earnings (subject to allowances below).
Annual and lifetime allowances
There are caps on how much you can contribute and still receive UK tax relief.
Once you exceed these allowances, additional tax charges may apply.
Annual allowance
Your annual allowance is the amount you can add across all private pensions each tax year before a charge applies.
The current annual allowance is £60,000. It may be lower if you have a high income (typically above £200,000) or if you’ve triggered flexible access.
You may be able to carry forward unused allowance from the previous three tax years.
Exceeding the allowance means the excess is added to your other income and taxed at your marginal rate. Relief is not given on the excess.
Lifetime allowance
The lifetime allowance (LTA) was the cap on total pension benefits built over a lifetime.
The LTA charge ended on 6 April 2023. From 2024/25 the LTA is abolished, though tax rules still apply to lump sums above the standard 25% tax-free amount unless you hold protection.
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Can I take some of my pension tax-free?
The minimum access age is typically 55 (rising to 57 from April 2028 depending on scheme rules).
You won’t pay Income Tax if your total income stays within your Personal Allowance.
Defined benefit pensions
A defined benefit pension pays a guaranteed income for life. Income above your Personal Allowance is taxable. Many schemes also offer a tax-free pension commencement lump sum (PCLS), commonly up to 25% of the benefits taken.
Defined contribution pensions
Most workplace or personal (defined contribution) pensions allow up to 25% tax-free cash. You can usually take it as one lump sum or as multiple smaller lump sums where 25% of each is tax-free.
Example: With a £1,000,000 pot, taking it all at once could mean £250,000 tax-free and £750,000 taxed as income. Taking £3,000 monthly would typically mean £750 tax-free and £2,250 taxable each month.
Is the State Pension taxed?
While theUK State Pensionis paid before tax is deducted, it counts as taxable income.
If it’s your only income, you’re unlikely to pay tax because the full State Pension is currently a little over £10,600 a year. Add private pensions and investment income and you may exceed your Personal Allowance.
Pension tax for expats
How much pension tax you pay as an expatdepends on tax residency, local rules and double taxation agreements (DTAs).
UK residents are typically taxed in the UK on pension income. Non-residents may be taxed in their country of residence.
DTAs help prevent the same income being taxed twice. The UK has an extensive treaty network — see HMRC tax treaties.
Some zero-income-tax jurisdictions (e.g., UAE) may allow pension income without local tax, subject to rules.
Given the complexity, seek specialist advice to ensure tax efficiency.
Tax when you have multiple sources of income
Multiple passive income streams can strengthen retirement finances. Examples include:
- Investment income
- Rental income from property investments
- Interest from savings
- Annuity income
You’re responsible for any tax due (e.g., Income Tax, Capital Gains Tax). You may need to complete a self-assessment tax return.
Can you avoid paying tax on your pension?
The only way to fully avoid tax is to keep total income below your Personal Allowance, which is rarely practical for living costs.
Instead, focus on being tax-efficient:
Drawdown schemes
Flexi-access drawdown can let you vary income year-to-year, helping manage tax bands. It carries investment and longevity risks, so take advice first.
Use ISAs
ISAs shelter interest, income and gains from tax. Main types include Cash, Stocks & Shares, Innovative Finance and Lifetime ISAs.
The annual ISA allowance is £20,000 (current rules). You can split across ISA types, with up to £4,000 in a Lifetime ISA.
Withdraw only what you need
Taking more than necessary can push you into higher tax bands. Leaving funds invested may reduce immediate tax.
Use the 25% tax-free amount
Most defined contribution schemes allow up to 25% tax-free from age 55 (rising to 57 in 2028). You can take a single lump sum or a series of smaller withdrawals.
Pension tax planning with Holborn Assets
Pension tax rules can be complex. Understanding them helps you maximise retirement income and avoid pitfalls.
Our advisers provide guidance on tax issues around pensions and broader retirement planning.
We’ll help you understand options and build a tailored strategy aligned to your goals.
Make sure your future plans remain on track. Book a free, no-obligation meeting today and learn how we can help you make the most of your pension savings.
