Do I Pay Tax on My Pension?

The short answer is yes, pensions are taxable, but not all of the money and not all at once. The system is designed so that a chunk comes out tax-free and the rest is treated as income, taxed at the same rates as a salary. Getting the order and timing right is the heart of tax-efficient retirement income.

The tax-free part

With most defined contribution pensions you can normally take up to 25% of the pot tax-free from age 55 (rising to 57 in 2028). This tax-free cash is capped by a lump sum allowance of £268,275 for most people. You can take it as one lump sum or in slices, and the remaining 75% stays invested until you draw on it. The way you build the pot also enjoys tax relief on the way in, so pensions are lightly taxed at both ends.

The taxable part

Everything beyond the tax-free cash is taxable as income when you draw it, whether through flexible drawdown, an annuity, or lump sums. It is added to any other income you receive and taxed at your marginal rate. The usual bands apply:

National Insurance is not charged on pension income, which is one reason a pension can be more tax-efficient than earned income of the same amount. But large withdrawals can push you into a higher band for the year, so pace matters. Taking £60,000 out of a pension in a single tax year, for instance, could see part of it taxed at 40%, whereas spreading the same amount over two or three years might keep every pound within the 20% band. The freedom to choose the timing is one of the biggest advantages of a defined contribution pension.

What about final-salary and State Pensions

Defined benefit or final-salary pensions are taxed in the same way: the income is added to your other earnings and taxed at your marginal rate through PAYE, though you may still be entitled to a tax-free lump sum at retirement. The State Pension, meanwhile, is fully taxable but stands slightly apart: it is paid without any tax taken off, which catches many people out. If the State Pension is your only income it typically falls within the £12,570 Personal Allowance and no tax arises; but combined with a private pension it can tip you over the allowance, and the tax on it is then recovered elsewhere.

How the tax is collected

Annuity and drawdown income is taxed through PAYE, just like a salary, using a tax code from HMRC. The State Pension is different: it is fully taxable but paid without any deduction, so HMRC recovers any tax due by reducing the tax code on your other pensions. A common surprise is emergency tax on a first flexible withdrawal, providers apply a temporary code that over-taxes the payment, which you then reclaim.

Keeping the bill down

Because you control when and how you draw a defined contribution pension, you have real influence over the tax. Taking tax-free cash in stages, staying within a band across the year, and blending pension income with ISA withdrawals (which are tax-free) can all reduce the total. A popular approach is to use the 25% tax-free element to top up income in years when you would otherwise stray into higher-rate territory, keeping the taxable portion inside the 20% band. Another is to defer drawing the pension at all in a year when other income is high, living instead off ISAs or cash savings.

It is also worth noting the wider picture: from April 2027 most unused pension funds will fall within the scope of Inheritance Tax, which changes the calculus around leaving a pension untouched purely to pass it on. Coordinating income tax efficiency with estate planning is exactly the kind of trade-off where advice earns its keep. Our guide to how much tax you’ll pay in retirement shows the income side in numbers. This is information, not personal advice, and investments can fall as well as rise; a vetted, FCA-regulated adviser via Vetted Wealth can build a withdrawal plan around your circumstances, free of charge.

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