What tax will you pay on your pension?

The information on this page should not be considered as financial advice. If you are unsure what’s right for you, please make sure you speak to a financial adviser. 

Pensions are classed as a form of income and are taxed once they exceed the personal allowance.

Whether you take an annuity, pension drawdown, combined  with your State Pension, you will have to pay tax still if you are receiving over the personal allowance. This guide will provide a representation of how tax works with pensions, and what you should know before you start taking your pension.

Do you pay tax on your pension?

Yes, you do pay tax on your pension if your income, including any pension income, is over the personal allowance. For the 24/25 tax year, the tax-free personal allowance is £12,570.

Anything you earn annually over £12,570 up to £50,270 is taxed at 20%. Between £50,270 and £125,140 is taxed at 40%, and then anything above that is taxed at 45%. Essentially, as it currently stands, tax bands don’t change when you retire.

Band	Taxable income	Tax rate
Personal allowance	Up to £12,570	0%
Basic rate	£12,571 - £50,270	20%
Higher rate	£50,271 - £125,140	40%
Additional rate	Over £125,140	45%

Tax rates correct for the 2024/25 tax year, data taken from gov.uk.

It’s worth bearing in mind that due to the way the tax-free personal allowance is treated, for anyone earning between £100,000 and £125,140, you actually pay an effective 60% tax rate on that portion of income. This is because once you earn more than £100,000 your personal allowance goes down by £1 for every £2 that your adjusted net income exceeds £100,000, and is zero if your income is £125,140 or above.

You should also be aware, the latest Budget saw inherited pensions – pension funds that are unused and death benefits payable from a pension – have been proposed to be added to the IHT limit under the latest reforms from April 2027 (subject to consultation).

How do tax-free pension payments work?

If you have a defined contribution pension, then 25% of your pension can be taken tax-free in most circumstances, subject to limits. Some people may take the money as one lump sum, others may take a series of smaller lump sums.

What do I get tax-free from a lump sum pension withdrawal?

Taking the money in a lump sum means that 25% of that single lump sum is tax-free, the remaining will be taxed as income. Some people take a lump sum before purchasing an annuity, or to reinvest it elsewhere. For example, if you had a pension of £50,000 and took it all in a lump sum, then you would get £12,500 tax-free, and you would pay tax on the remaining £37,500.

What do I get tax-free from a pension drawdown?

If you choose to take a pension drawdown, where you receive smaller and regular payments from your pension, then you will get 25% of each payment tax-free and pay tax on the rest. For example, if you had a £50,000 pension and chose to take 10 payments of £5,000, then you would get £1,250 tax-free and pay tax on the remaining £3,750 each time you received a payment.

What do I get tax-free from a defined benefit pension?

Defined benefit pension schemes will offer the option of taking a tax-free lump sum as well as receiving your guaranteed income. Your guaranteed income from your defined benefit pension will be treated as income and is therefore taxable.

What do I get tax-free from an annuity?

Before you purchase an annuity, you can take 25% of your pension pot as a tax-free lump sum, subject to limits. Then, the remaining 75% can be used to purchase an annuity. If your annuity income pushes you over the tax-free personal allowance, then you will have to pay income tax on each payment, like you would with a salary.

What about pensions and emergency tax codes?

Single or ad-hoc payments, or initial payments of regular pension income, are normally taxed on the ‘Emergency month 1 basis’. The emergency tax code will often result in an overpayment of tax - but for additional rate taxpayers, it could result in an underpayment. Pension providers may provide you with information, but if you are unsure as to what tax code you are on and how this will affect what you pay, it’s best to check with an accountant or financial adviser who will be able to assess the situation.

Tax on the state pension

Your state pension is only taxable if it plus any other pension income exceeds your total annual income pushes you over the tax-free allowance. The State Pension is taken into account first in any allowance calculations. In 2024/25 the maximum State Pension you could receive was around £10,600 annually, which is below the tax-free allowance. If you rely solely on the State Pension, then you won’t pay tax. If you earn extra income, whether from a job or annuity, then you may need to pay tax.

Let’s use an example. Sheila receives her State Pension and works a part-time job to boost her income. She receives the £203.85 a week from the State Pension and receives £307.69 a week from her part-time job (annual salary of £16,000). Her total annual income is £26,600 so Sheila must pay tax on £14,030 of her income.

State pension income	Income	Tax-free allowance	Taxable income	Income tax sum
£10,600	£16,000	£12,570	£14,030	£2,806

Data based on 2024/25 tax figures and are subject to change. These are an illustration, rather than a confirmed result.

Tax on personal pension (SIPP)

Like a workplace pension, your personal pension may be taxed differently depending on how you withdraw it. If you take it as a lump sum, you’ll pay income tax on 75% of it, if you take it as a drawdown then you’ll pay income tax on 75% of each payment. You could pay income tax on 100% if you take the 25% tax-free cash and the remainder in one go.

Pension option tax calculations

With so many ways to take your pension, knowing what is and isn’t tax-free can be complicated. This table will summarise what we’ve covered in this guide, so you can be confident in your options. 

The pension options	What's tax-free	What's taxable
Leave your pension as is	Your whole pot, until you withdraw any money	Nothing while your pot stays as is
Annuities	25% of your pot before you buy an annuity	Income from the annuity
Pension income drawdown including fixed term annuities	25% of your pot before you move the rest to get a flexible income	Income you take
Take your pension pot as several lump sums	Take your pension pot as several lump sums 25% of each amount you take out 75% 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

 

Get the most out of your pension with impartial retirement advice

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