We’re now less than a year away from some big changes to pensions and taxes. In the second part of our two-part series, here are some of your most popular pension questions answered.
This article isn’t personal advice. Pension and tax rules can change, and benefits depend on your circumstances. You can normally access the money in a pension from age 55 (rising to 57 in 2028). Scottish taxpayers have different tax rates and bands. If you’re not sure if an action is right for you, ask for financial advice.
The Government offers a free, impartial service to help you understand your retirement options. Find out more about Pension Wise.
Do I have to take my 25% tax-free cash in one go?
No, you don’t generally have to take any tax-free cash in one go.
If your provider offers phased drawdown then you can take your tax-free cash gradually by moving into drawdown in stages over time. This can help with managing your tax liabilities and keeping under certain thresholds by using tax-free cash to supplement your income.
Uncrystallised Funds Pension Lump Sum (UFPLS) also lets you take tax free cash in stages by taking lump sums from your pension without going into income drawdown. 25% of each lump sum will normally be tax free and the remainder taxed. But this does potentially mean you face a higher tax bill.
Taking an UFPLS or income from most drawdown arrangements will also trigger the Money Purchase Annual Allowance as you’re taking income flexibly, so you would then be restricted to contributing £10,000 per year to any defined contribution pensions.
Do I pay tax on pension income?
Up to 25% of your personal and workplace pensions can usually be taken tax-free. Beyond that if your pension income is taxed depends on your total income. If your total taxable income is more than your personal allowance, then you will pay tax on the amount you’re over – and this does include the state pension.
From April the full new state pension will stand just below the standard personal allowance (£12,570). So, even drawing a small taxable income from elsewhere will tip you into tax paying territory, even if you have no other income.
From April 2027 it’s expected that the full new state pension alone will breach £12,570, potentially pulling more pensioners into taxpaying territory.
The government announced at the last Budget that from April 2027 any pensioner living solely on the state pension would not have to pay tax on it. But this won’t cover income from the additional state pension – otherwise known as the state second pension. We’re awaiting further detail on how this will work and how long it’s expected to last.
If you’re married, you can each manage your individual pension income and tax allowances to manage your overall tax bill.
What options do I have at retirement?
There are usually a few options when it comes to taking an income at retirement from a defined contribution pension.
If you want a guaranteed income, then you could consider using part or all of your pension to purchase an annuity. This will pay you an income for life and you choose whether you get one that pays out a level income or one that increases every year.
Different providers offer different rates, and you can get annuities that will also pay out an income to your spouse/civil partner when you die. But remember, an annuity cannot normally be unwound, so you need to make sure you take your time to assess the market and get the best type of annuity for you.
You can also opt to remain invested in the market and take an income via income drawdown. This is more flexible than an annuity, but you do need to remember that markets go up and down in value, and you could get back less than you invested. You also need to make sure that the income you’re taking is sustainable over time. You can always combine income drawdown with an annuity and secure a level of guaranteed income while retaining flexibility.
UFPLS lets you withdraw funds directly from your pension pot without moving into income drawdown. Each withdrawal will normally be 25% tax free, so you don’t have the option of taking a tax-free lump sum. You also have the option to take out your entire pension at once. This does have the potential of leaving you short of cash later but can be an option when people have other larger pensions elsewhere.
It’s often a good idea to get financial advice about retirement income to make sure you take the right approach for you. Or you can use the Government’s free, impartial Pension Wise service to learn more about your retirement options.
What is lifestyling and do you need it?
Lifestyling is an investment approach where, as you get closer to retirement, your pension automatically moves out of shares into so-called less risky assets like bonds.
The idea is to shelter your pension from stock market volatility the closer you get to retirement. However, this may not suit your needs. For instance, if you wanted to stay in income drawdown in retirement you might want to be invested in shares instead of moving into bonds. So it’s well worth checking with your scheme and seeing what other options there are.
Can a pension be inherited?
Yes, depending on the type of pension you have, it can be inherited by your children or other beneficiaries.
If you have a defined benefit pension scheme, then you need to check the scheme rules. Some will allow for a child to inherit under certain circumstances, but others only allow a spouse or civil partner to receive the death benefits.
If you have a defined contribution pension, like a Self-Invested Personal Pension (SIPP), then it’s generally different. You just need to fill out your expression of wish form, so the administrators know who you would like your pension to go to in the event of your death. Not keeping these up to date can cause delays and frustration at an already difficult time and can even mean an ex-partner could potentially inherit at the expense of a current one. It’s worth noting that expression of wish forms aren’t binding, but they must be taken into account by the scheme.
If you die before the age of 75 then your beneficiaries won’t normally have to pay income tax on what they inherit. If you’re age 75 or over then they will, but it will be at their marginal rate, not yours.
As it currently stands, pensions are not usually part of your estate for inheritance tax purposes but, from April 2027, most will be so you need to be aware of any potential tax bill your beneficiaries might receive.
Stay a step ahead
Inheritance tax is just one of the ways your finances are changing at the end of this tax year. Our weekly newsletter gives you news, tips and insights on these changes right in your inbox.
