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How much tax will I pay on my pension withdrawals?

Here’s everything you need to know about how pension withdrawals are taxed and one way you could reduce your tax bill.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

We all work hard to build up our pension pots over the years, so it’s important you understand how tax works when you start to access your retirement pot. After you take your tax-free cash, pension withdrawals are taxed as income.

In the last three months of 2021, HMRC reportedly returned more than £42 million to around 13,579 pension investors. On average, this means each of these people overpaid around £3,100 in tax on their pension withdrawals until they received their tax rebate.

With taxes rising and the cost-of-living soaring, it’s important that you understand tax rules and don’t pay more than you need to. Here’s everything you need to know about how your pension withdrawals will be taxed - and one way you could reduce your tax bill.

This article isn’t personal advice. If you’re not sure what’s right for you, ask for financial advice. Pension and tax rules can change, and benefits depend on your circumstances.

How is my pension taxed?

Usually, you can take up to 25% of your pension as tax-free cash once you reach age 55 (rising to 57 in 2028). You can take this as a single payment, or in stages – it depends on what you decide to do with the rest of your pension. The rest of your pension is taxable, and when withdrawn is added to any other income you receive in the same tax year.

If you have a defined benefit (e.g. final salary) pension, the scheme rules will affect how much tax-free cash you can get, and when you can take it.

Taking large or infrequent pension withdrawals could push you into a higher tax band, and mean a hefty tax bill. It’s important you plan for this before making any decisions.

When do you start paying tax?

Most people can earn £12,570 per tax year without having to pay income tax - this is known as your personal allowance. For people earning £100,000 or more the personal allowance of £12,570 is reduced by £1 for every £2 of income above £100,000. For any income above this amount, various tax bands and tax rates apply, rising to 45% tax on income over £150,000. The graph below illustrates the different UK tax bands.

Stacked bar chart demonstrating different tax bands

Find out more about the rules for Scottish taxpayers

Timely pension payments and cumulative tax codes

Most tax codes are applied on a cumulative basis, which means more of your Personal Allowance becomes available as the tax year progresses in equal proportions each month. This makes it important to plan your pension payments carefully, or you might get taxed more that you expect.

For example, if a pension payment is made on 28 April (in the first tax month of the tax year) the tax deducted will be worked out based on 1/12th of the tax allowances and income bands indicated by your tax code. If the payment was taken on 28 March (in the last month of the tax year), the tax deducted will be worked out based on 12/12th of your tax-free allowance and tax bands.

In practice, regular payments should have equal tax taken off. But those taking single or infrequent payments early in the tax year could initially be over-taxed and they’d have to wait for a tax rebate before this was repaid to them.

Try our income tax calculator

How to avoid overpaying tax on pension withdrawals

Taking large withdrawals from your pension can push you into a higher tax band and lead to a hefty tax bill. A sensible approach could be to spread your withdrawals across more than one tax year to make the most of your personal allowance and tax brackets. This could mean you pay less tax or in some cases you could take your pension income completely tax free.

While it’s important to avoid not paying more tax than you need to, all pension withdrawals should be based on your personal circumstances and the need to support your lifestyle requirements in retirement.

Married or in a civil partnership?

If you’re married or are in a civil partnership, then you could also make use of the marriage allowance to mitigate some tax liability on your pension payments.

If one spouse’s income is below the personal allowance (non-taxpayer) while the other has an income of less than £50,270 (basic-rate taxpayer) the marriage allowance lets the non-taxpayer give £1,260 of their personal allowance to their spouse in the current tax year.

To put this into context, let’s say you withdraw £10,000 and your spouse withdraws £30,000. Their taxable income would be £17,430 (as the first £12,570 is tax free).

As the non-taxpayer, if you claim marriage allowance, you could transfer £1,260 of your personal allowance to your spouse. Your personal allowance becomes £11,310 and your spouse gets a ‘tax credit’ on £1,260 of their taxable income.

HOW TO CLAIM MARRIAGE ALLOWANCE

Watch out for the emergency tax code

By taking your first taxable income payment from a pension, it’s likely the emergency tax code will be applied. This code doesn’t take other income into account and assumes you will receive the same amount each month. It’s likely to result in the incorrect amount of tax being deducted initially, especially when making one-off lump sum withdrawals.

If you have a P45 from the same tax year that you take your first income payment, you should send this to your pension provider as they might be able to apply the correct tax code using that information. Otherwise they will need to wait for your correct tax code otherwise, your provider will need to wait for your correct tax code to be confirmed by the HMRC.

Try our emergency tax calculator

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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