How Much Tax Will I Pay on My Pension? Your UK Guide to Tax-Efficient Retirement
Understand how your UK pension is taxed. Our guide covers tax-free cash, income tax on withdrawals, drawdown, and how to reduce your tax bill in retirement.
You’ve spent decades diligently saving into your pension. But as you approach retirement, a crucial question arises: how much of that hard-earned money will you actually get to keep, and how much will go to the taxman? Understanding pension taxation is fundamental to making your retirement savings work as hard as possible for you.
At Plouta, we believe in empowering you with clear financial knowledge to help you make smart decisions for your future. This guide will demystify how pensions are taxed in the UK for 2025, explain how you can access your money, and explore legitimate strategies to minimise the tax you pay in retirement, helping you on your journey to financial freedom.
What You Will Learn in This Guide ⤵
The Golden Rule: Tax-Free Cash: How to take your 25% tax-free lump sum.
Tax on Pension Income: Understanding how pension withdrawals are taxed like a salary.
The State Pension & Tax: A crucial point many people overlook.
Pension Withdrawal Scenarios: How tax applies when taking lump sums vs. a regular income.
The Money Purchase Annual Allowance (MPAA): A trap to be aware of if you continue saving.
Strategies to Reduce Your Tax Bill: Practical ways to plan your withdrawals efficiently.
Pensions & Inheritance Tax: What happens to your pension when you die.
The First and Most Important Rule: Your Tax-Free Lump Sum
Let's start with the best news. For most people with a "defined contribution" pension (the modern pots most people have, including workplace and personal pensions/SIPPs), you can usually take up to 25% of your pension pot completely tax-free.
This is officially known as the Pension Commencement Lump Sum (PCLS). You can typically access this from age 55 (rising to 57 from 2028).
Example: If your pension pot is worth £100,000, you can take up to £25,000 as a tax-free lump sum. The remaining £75,000 stays invested in your pension to provide you with a taxable income.
Important Note: The previous Lifetime Allowance, which capped the total amount you could save in a pension, was abolished from April 2024. However, it was replaced by new allowances capping the amount of tax-free cash you can take. For most people, the tax-free lump sum is capped at 25% of their pot, up to a maximum of £268,275 (which is 25% of the old £1,073,100 Lifetime Allowance), unless you have specific protections.
How is the Rest of Your Pension Taxed?
After you've taken your tax-free lump sum (or if you choose not to), any further money you take from your pension is taxable as income.
Think of it like a salary. It's added to all your other taxable income for the year (such as State Pension, earnings from a part-time job, or rental income). The total amount will determine which Income Tax band you fall into.
The State Pension is Taxable (But Paid Gross)
This is a critical point that often catches people out. The UK State Pension is taxable income.
However, it is paid to you "gross," meaning no tax is deducted before it reaches your bank account. HMRC knows you receive it and will collect the tax due by reducing your tax-free Personal Allowance against your other income sources, like your private pension or workplace pension. This means your private pension provider will be instructed (via your tax code) to deduct more tax from your private pension payments to cover the tax owed on your State Pension.
Pension Withdrawal Scenarios & Tax
How you're taxed can depend on how you take your money:
Flexible Income (Drawdown): You take a 25% tax-free lump sum, and the rest of your pot stays invested. You then draw a taxable income from the remaining pot as and when you need it. Each withdrawal is added to your income for that year and taxed accordingly.
Lump Sums (UFPLS): You can take smaller lump sums directly from your pension pot instead of a regular income. For each lump sum, 25% is tax-free, and the other 75% is taxed as income.
Emergency Tax Warning: When you take your first flexible withdrawal (either via drawdown or UFPLS), your pension provider often has to put you on an emergency tax code. This assumes you'll be taking that same amount every month, which can lead to a large initial overpayment of tax. You can claim this back from HMRC, but it's an administrative hurdle to be aware of.
Buying an Annuity: You use your pot (after taking tax-free cash) to buy a guaranteed income for life. This income is then taxed just like any other income via PAYE.
How Can I Avoid (or Reduce) Pension Tax? Smart Strategies
You can't completely avoid tax on pension income above your Personal Allowance, but you can be smart about minimising it.
Use Your Tax-Free Lump Sum Wisely: Taking your 25% tax-free cash is the single biggest tax benefit at retirement.
Manage Your Withdrawals to Stay in a Lower Tax Band: This is the most effective strategy. Instead of taking large, infrequent lump sums that could push you into the higher (40%) or additional (45%) rate tax bands for that year, consider taking smaller, regular payments.
Example: If you need £40,000, taking it all in one go could result in a significant tax bill. But if you spread it over two tax years (£20,000 each year), you could potentially stay within the basic-rate tax band for both years, paying much less tax overall.
Use Your Personal Allowance Each Year: Aim to use your £12,570 tax-free Personal Allowance annually. If your State Pension is, for example, £11,500, you have around £1,070 of Personal Allowance left. This means you could withdraw £1,070 from your private pension completely tax-free each year.
Consider Your Spouse's Tax Position: If your spouse or civil partner is a non-taxpayer or basic-rate taxpayer, you could plan withdrawals between you to make use of both of your Personal Allowances and basic-rate tax bands, potentially reducing the overall tax paid as a household.
"Small Pots" Rule: If you have several small pension pots (under £10,000 each), you may be able to take them as a lump sum under "trivial commutation" or "small pot" rules. You can take up to three small pots of up to £10,000 from non-occupational schemes. As with UFPLS, 25% is tax-free and 75% is taxed at your marginal rate. This can be a simple way to access small pots without triggering the MPAA (see below).
The Money Purchase Annual Allowance (MPAA) - A Crucial Trap
Once you start taking a flexible taxable income from your defined contribution pension (e.g., via drawdown or taking an UFPLS lump sum), you will usually trigger the Money Purchase Annual Allowance (MPAA).
What it is: The MPAA dramatically reduces the amount you can continue to save into a defined contribution pension with tax relief each year. The standard Annual Allowance is £60,000, but the MPAA is currently just £10,000.
Why it matters: If you plan to work part-time in retirement or continue saving, triggering the MPAA could severely limit your ability to build up further pension savings tax-efficiently.
Note: Taking only your 25% tax-free cash and not drawing any income from the remaining pot does not usually trigger the MPAA.
Pensions & Inheritance Tax (IHT)
One of the most significant benefits of modern pensions is that they normally sit outside of your estate for Inheritance Tax purposes. This makes them a very tax-efficient vehicle for passing on wealth.
If you die before age 75: Your beneficiaries can usually inherit the entire remaining pension pot completely tax-free.
If you die after age 75: Your beneficiaries will pay Income Tax on any withdrawals they make from the pension pot at their own marginal rate.
Plouta Tip: Always complete a "Nomination of Beneficiary" or "Expression of Wish" form with your pension provider to let them know who you'd like your pension to go to.
Know Where You Stand: Take the Plouta Financial Wellness Survey
Taking our Financial Wellness Survey is a great first step. It will help you reflect on your habits and identify the key areas to focus on in your journey towards financial freedom.
Frequently Asked Questions (FAQs) about Pension Tax
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No, you don't. While taking 25% of your whole pot in one go is a popular option (if you then buy an annuity or move the rest into drawdown), you can also take smaller lump sums as and when you need them. This method is often called Uncrystallised Funds Pension Lump Sum (UFPLS). With UFPLS, each withdrawal is treated as 25% tax-free and 75% taxable income.
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This is a very common issue. When you first take a flexible, taxable withdrawal from your pension, your provider often doesn't have an up-to-date tax code from HMRC for that payment. To ensure enough tax is paid, they are required to apply an "emergency tax code" on a "Month 1" basis. This treats your one-off withdrawal as if you'll be receiving that same amount every month of the year, which can result in a significant initial overpayment of tax.
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You can claim back overpaid tax from HMRC. You don't have to wait until the end of the tax year. You can do this by:
Filling out form P55 if you've only taken part of your pot and won't be taking more withdrawals in that tax year.
Filling out forms P50Z (if you've emptied your pot and stopped working) or P53Z (if you've emptied your pot but have other income). These forms are available on the GOV.UK website. Alternatively, HMRC will usually work out that you've overpaid and send you a P800 tax calculation after the tax year ends.
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Yes, potentially. Just like any other income, your total pension income is added to your other earnings. If your total "adjusted net income" for the tax year goes over £100,000, your standard Personal Allowance (e.g., £12,570 in a recent tax year) starts to reduce. It is reduced by £1 for every £2 your income is over this threshold. This means if your income is £125,140 or more, you will have no tax-free Personal Allowance at all.
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Yes. Although the State Pension is paid to you without any tax being deducted, it is taxable income. HMRC will add it to your other income for the year. To collect the tax due on it, they will usually reduce your tax-free Personal Allowance that can be used against your private/workplace pension or any employment earnings.
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This is a key benefit of modern defined contribution pensions. They normally sit outside of your estate for Inheritance Tax (IHT) purposes.
Death before age 75: Your beneficiaries can usually inherit the entire remaining pension pot completely tax-free.
Death after age 75: Your beneficiaries will pay Income Tax on any withdrawals they make from the pension, at their own marginal rate. (Note: The UK Government has announced its intention to change these rules from April 2027, which could make unspent pensions subject to IHT. It's vital to stay updated on this potential change).
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No. Simply taking your 25% tax-free lump sum and moving the rest of your pot into a drawdown fund (without taking any income from it) does not trigger the MPAA. The MPAA is only triggered when you start to take a flexible taxable income from your pot.
Quick Takeaway Points
25% is Tax-Free: You can usually take up to a quarter of your defined contribution pension pot tax-free from age 55 (57 from 2028).
The Rest is Taxable: Any income or lump sums taken beyond the tax-free amount are added to your other income and taxed at your marginal rate (0%, 20%, 40%, 45%).
State Pension is Taxable: This reduces your tax-free Personal Allowance that can be used against your private pension income.
Plan Your Withdrawals: Taking smaller amounts each year, rather than large lump sums, is the key strategy to avoid being pushed into higher tax bands.
Beware the MPAA: Taking flexible taxable income will likely reduce your future pension contribution allowance from £60,000 to £10,000 per year.
Pensions are IHT-Friendly: They are generally outside your estate for Inheritance Tax purposes, making them a great way to pass on wealth.
Conclusion: Planning is Key to a Tax-Efficient Retirement
While you can't avoid tax on your pension income entirely, you have significant control over how much you pay and when. The flexibility of modern pensions is a great benefit, but it also brings responsibility. By understanding the rules around tax-free cash, planning your withdrawals strategically to manage your tax bands, and being aware of traps like the MPAA, you can make a substantial difference to your net retirement income.
A tax-efficient retirement isn't about avoidance; it's about smart planning. It ensures that the pot you've worked so hard to build provides you with the maximum possible benefit, supporting you on your journey to a secure and comfortable future.
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Disclaimer: This guide provides general information about UK pension taxation based on rules and allowances known as of June 2025. Tax laws are complex and subject to change. Your personal circumstances, including where you live in the UK (Scotland has different income tax rates), will affect your tax liability. This information does not constitute financial or tax advice. You should always seek professional, regulated financial advice tailored to your specific situation before making any decisions about your pension.