Pension Income

Tax on pension income

Whilst pensions benefit from tax free growth and favourable tax breaks on contributions, when the time comes to draw an income from your pensions you are still required to pay income tax. However, when you take money from your pension 25% is tax free and you pay income tax on the other 75%. 

The first £12,500 of any person’s income is their ‘Personal Allowance’ and is tax free. The 25% tax free amount from your pension does not use up your personal allowance, so the total tax you pay will depend on how much income you are making for the year.

There are two ways you can take your 25% tax free amount. The first option is to take it all at once, but if you do this you can’t leave the remaining 75% untouched and would either have to draw an income from the remainder flexibly or purchase an annuity.

The other option would be to take it in chunks. In this instance 25% of ever chunk you take would be tax free and the remainder would be taxable.

The pension provider will deduct the tax before paying you, much in the same way your income from an employer arrives in your bank post tax. This is a key reason pension consolidation is so popular as having multiple schemes can easily lead to overpaying or underpaying tax and create a more complicated administrative process for you.

How each pension option is taxed

This table gives an overview of how much tax you may pay on the money you take from your pension pot.

 

The pension options

What’s tax free

What’s taxable

Leave your pot untouched

Your whole pot while it stays untouched

Nothing while your pot stays untouched

Guaranteed income (annuity)

25% of your pot before you buy an annuity

Income from the annuity

Adjustable income

25% of your pot before you invest in an adjustable income

Income you get from your investment

Take cash in chunks

25% of each amount you take out

75% of each amount you take out

Take your whole pot in one go

25% of your whole pot

75% of your whole pot

Mix your options

Depends on the options you mix

Depends on the options you mix

 

Making sure you drawdown from your pensions as tax efficiently as possible is critical and planning carefully around your actual needs could help to reduce your tax bill. If you are heading towards retirement it would be prudent to seek advice to make sure you are prepared and well placed to get exactly what you need from your pensions. The process of pension planning can be further complicated if you are retiring abroad. Expats will need to understand the agreements in place between the UK and the country they are now residing in.

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