The amount of tax you’ll pay when taking money out of your pension depends on how much you want to withdraw, and on which tax bracket you fall into.
You can usually withdraw up to 25% as a tax-free lump sum from a defined contribution pension once you reach the age of 55 (rising to 57 in 2028), but the rest will be treated as income for tax purposes.
However, taking chunks out of your pension can have a significant impact on your future retirement income, and the amount of tax you pay on withdrawals. If you’re not careful, you could push yourself into a higher tax bracket, leaving you with a hefty tax bill that might have otherwise been avoided. You can find out more about some of these risks in our guide Four big risks of dipping into your pension.
Here we explain how much tax you’ll pay on any pension withdrawals, and how to keep your potential tax bills to a minimum.
- How much of my pension is tax-free?
- How much tax do you pay on your pension withdrawals?
- Do you pay tax on your State Pension?
- How can you reduce the amount of tax you pay on your pension?
- How much tax will I pay on my pension if I’m still working?
- What about other tax liabilities on your pension?
- Where to get more help
How much of my pension is tax-free?
As mentioned above, you can usually take up to 25% of your pension as a tax-free lump sum from a defined contribution pension, which is the most common type of pension. The amount you receive when you retire from a defined contribution pension depends on how much you have paid into it, how much your employer has contributed (if it’s a workplace pension), how the investments made on your behalf have performed, and how much you’ve paid in charges.
Find out more about withdrawing a tax-free lump sum from your pension in our article Should I take my tax-free pension cash at 55? and about defined contribution pensions more generally in our guide What is a defined contribution pension?
Under pension freedom rules, which only apply to defined contribution pensions, you are able to cash in as much as you like of your pension as a cash lump sum, so it’s not limited to 25% of your pot. However, cashing in a pension isn’t usually a good idea unless it’s a very small pot, when you might want to withdraw the entire amount, or transfer it to another pension instead. Read more in our articles Cashing in small pensions: what you need to know and Should I consolidate my pensions?
If, for example, you withdrew £50,000 from your pension as a lump sum, this money would be included as income for that tax year, and taxed at your marginal rate. This could push you into a higher rate tax band of 40% or more, which is likely to wipe out any of the tax benefits you made by initially investing in your pension.
If you have a defined benefit, or final salary pension, you’ll usually be able to take a tax-free lump sum from this too, alongside a guaranteed income for the rest of your life. You can ask your pension scheme for more details on the exact amount, and beware that the larger the lump sum you take, the less you are likely to receive as a guaranteed income when you stop working. Read more about how this type of pension works in our article What is a defined benefit pension?
How much tax do you pay on your pension withdrawals?
Aside from your 25% tax-free lump sum, your pension withdrawals are taxed in the same way as other income, so as if you received the money as a salary.
However, you have a Personal Allowance, which entitles you to earn up to £12,570 tax free in the 2023/24 tax year. You receive this once against all of your income. Beyond this, you’ll pay tax at your marginal rate, and the amount payable will depend on the amount of income you earn, with the basic rate at 20%, the higher rate at 40% and the additional rate at 45%, as shown on the table below (these income thresholds apply to the 2023/24 tax year).
|Tax band||Taxable income||Tax rate|
|Personal Allowance||Up to £12,570||0%|
|Basic rate||£12,571 to £50,270||20%|
|Higher rate||£50,271 to £125,140||40%|
|Additional rate||over £125,140||45%|
You can use the Rest Less pension calculator to get an estimate of the income you’ll receive at retirement based on your pension’s value. This can include your State Pension entitlement if you want it to, and you can also see the impact of taking 25% of your pension as tax-free cash. You can amend your retirement age and the level of income you want as well, to see how these affect the length of time your pension will last.
Do you pay tax on your State Pension?
The income you receive from your State Pension payments is also taxable, but whether you pay tax on this again depends on your total income. The current maximum new State Pension is £203.85 a week in the 2023/24 tax year, or £10,600 a year. Find out more in our article How the State Pension works.
If your only income is from the State Pension, then this falls within your Personal Allowance, so you won’t pay any income tax. However, if you have income from personal and/or workplace pension schemes, or any other sources, for example a buy to let property or part-time work, you will pay income tax at your personal rate on any amount above the £12,570 personal allowance.
For example, Sue receives the full new State Pension, and also draws a total of £10,000 from her pension one year. Her total income for the year is £20,600. After her personal allowance of £12,570 this leaves £8,030 to be taxed at the basic rate for income tax of 20%, which amounts to a tax bill of £1,606.
|State Pension||Pension withdrawals||Personal Allowance||Taxable income at the basic rate of 20%||Tax bill|
How can you reduce the amount of tax you pay on your pension?
In simple terms, the less income you take from your pension, the lower your tax bill will be, so if you can, ideally you should only take the amount you need from your pension each year. If you’re thinking of withdrawing money from your pension to top up your income, you can read more about the impact of doing this in our article Should I use my pension to boost my income?
However, of course, you’ll need to take enough to meet your living expenses, and these will vary depending on your individual circumstances. Many people choose to take income from their pension using a flexible drawdown plan, as this enables you to vary the amount you take from your pension and may help you keep your tax bills down if you manage withdrawals carefully.
Read more about drawdown in our article What is pension drawdown and how does it work?
It can be tricky knowing how much to take from your pension each year whilst keeping tax bills to a minimum, and ensuring you don’t run out of money too soon, but a financial advisor can help you to manage this (see below). You can read more about how other members manage their pension withdrawals in our article Rest Less members: what is your pension income plan?
If you receive your retirement income from an annuity, you won’t be able to vary the amount you receive each year to potentially reduce your tax bills. The income you receive from an annuity is usually fixed, though it may rise in line with inflation depending on the type of annuity you bought. Learn more about how annuities work in our guide Annuities explained.
How much tax will I pay on my pension if I’m still working?
You can continue working beyond the age you start withdrawing from your pension, by which time you might have a variety of income sources. For example, you may choose to work part-time and to supplement your income from your retirement pot. Read more in our article How can I phase my retirement?
You will pay tax on any income over your £12,570 Personal Allowance, and this income may come from employment, pensions, savings or property, for example. Bear in mind that you have other allowances, too. For example, you can receive £1,000 a year from dividends as an income, with any amount above this subject to the dividend tax rate. Find out more in How much tax you pay – tax rates and allowances.
You also have a Personal Savings Allowance (PSA) in addition to your Personal Allowance. This enables you to receive interest of up to £1,000 from your savings each year before paying tax as a basic rate taxpayer, while higher rate taxpayers can receive up to £500 a year from their savings. Plus, if your total annual income is less than your £12,570 Personal Allowance, your Personal Savings Allowance rises to £6,000 (although you’d need an awful lot of savings to receive this much interest a year!)
Ultimately, the amount of tax you pay is calculated based on your total income, minus allowances, and how you pay any tax due depends on the source:
|Income source||How you pay tax|
|Employment||Employer deducts using Pay As You Earn (PAYE)|
|Self-employment||You pay directly to HMRC after completing a tax return|
|Personal pension||Your provider deducts tax automatically, so you receive payment after tax|
|State Pension||HMRC deducts tax automatically|
|Savings||You pay tax on interest above your Personal Savings Allowance (PSA) directly to HMRC|
|Investments||You pay tax to HMRC after completing a tax return (above your £1,000 a year dividend allowance)|
|Buy-to-let property||You pay tax to HMRC after completing a tax return|
What about other tax liabilities on your pension?
There are two main pension allowances that you should be aware of that have tax implications.
You can pay up to £60,000 a year into a pension and earn tax relief on this, which is known as your Annual Allowance. If you pay more than the Annual Allowance into your pension, you’ll have to pay what’s known as an Annual Allowance charge. HMRC has an Annual Allowance calculator to help you work out whether you have to pay tax on your pension savings.
The Annual Allowance charge isn’t a fixed rate – the amount you’ll pay will depend on which income tax bracket you’d fall into if your excess pension savings are added to any other taxable income you get. So, for example, the charge could be 20%, 40% or 45% of any pension savings you made above the Annual Allowance, depending on your circumstances.
Previously, there was also the Lifetime Allowance to consider, which limited the total amount that you can save into your pension over your lifetime without facing a tax charge, however this was abolished in 6 April 2023.
You can read more in our article How do pension allowances work?
Where to get more help
Working out your pension income options and keeping your tax bills down can be complicated, so if you’re not sure how to proceed, you may want to seek professional advice. If you’re 50 or over and have a defined contribution pension, you can get free guidance on the options available from the Government’s Pension Wise service.
If you’re considering getting professional financial advice, Aviva is offering Rest Less members a free initial consultation with an expert to chat about your financial situation and goals. There’s no obligation, but if they feel you’d benefit from paid financial advice, they’ll go over how that works and the charges involved.