How will my retirement income be taxed?

How will your retirement income be taxed?

Understanding how your retirement income will be taxed is an important part of developing your retirement income plan. This article explains the main points that you need to think about. Remember, tax can be complicated - you should always get tailored advice from an expert before acting.

The value of any tax relief will depend on individual circumstances, which may change.

This information is based on our understanding of current taxation law and HM Revenue & Customs (HMRC) practice, which may change.

Cash lump sums

You can take part or all of your full pension pot as a cash lump sum. If you do this, normally 25% of each payment is tax free, and the remaining 75% is taxed as income. Unless a tax code is already held for you, when you take your first lump sum, you’ll pay emergency tax on the taxable portion of the lump sum.

HMRC require that the emergency tax code should operate on a "month one" basis. This means that one twelfth of the personal allowance for that tax year will be allocated towards it. As a result, you’ll only get a maximum of one month’s tax-free allowance against the first payment regardless of when it occurs in the tax year. The personal allowance for the 2024/25 tax year is £12,570, so the one month allowance is £1,048 (owing to the rounding that is used in the calculations). You can find the personal allowance at www.gov.uk/income-tax-rates.

Please note, if you’re a Scottish taxpayer, the emergency tax code is applied in the same way as it is for taxpayers in the rest of the UK. In the examples below we’ve assumed that:

The first lump sum taken is a full lump sum
The emergency tax code applies on a month one basis
The tax-free allowance and the tax bands are shown to the nearest pound.

Example one
Lump sum amount	£2,000.00
Tax-free element	£500.00
Taxable element	£1,500.00
Tax-free allowance	£1,048.00
Total taxable pay:	£452.00
£452.00 @ 20%	£90.40
Total tax due:	£90.40
Amount payable to investor	£1,909.60

Example two
Lump sum amount	£40,000.00
Tax-free element	£10,000.00
Taxable element	£30,000.00
Tax-free allowance	£1,048.00
Total taxable pay:	£28,952.00
£3,142.00 @ 20%	£628.40
£7,287.00 @ 40%	£2,914.80
£18,524.00 @ 45%	£8,335.80
Total tax due:	£11,879.00
Amount payable to investor	£28,121.00

Please bear in mind that the main purpose of your pension fund is to secure your financial future. Unless you budget accordingly, or have other investments to give you an income, there's a risk that your lump sum may run out before the end of your lifetime.

It may be more tax efficient to spread your withdrawals over successive tax years and take a series of lump sums. This way you don’t have a single income spike in one tax year, and you may reduce the amount of income that falls into a higher tax bracket.

Refunds for overpaid tax

If the use of the emergency tax code means the lump sum is over-taxed (including where you are a Scottish taxpayer), HMRC will refund the excess.

Full lump sums

You can contact HMRC after you receive the payment to claim an in-year refund. Please complete the appropriate form to claim back your tax:

If the payment used up your pension pot and you have no other income in the tax year, complete form P50Z.
If you have taken a small lump sum (sometimes known as a small pot) payment, the payment has used up your pension pot and you have other taxable income, complete form P53.
If you have taken an Uncrystallised Pension Funds Lump Sum (UFPLS) or a serious ill-health payment, the payment has used up your pension pot and you have other taxable income, complete form P53Z.

Partial lump sums

If we don’t have your correct tax details, HMRC will provide us with a revised tax code to make sure we apply the correct amount of tax to any future payments, and possibly refund any overpaid tax from the first payment. If the wrong amount of tax is deducted and:

Further lump sums are paid in the tax year – if you intend to make further lump sum withdrawals and/or take income in the current tax year, we’ll normally pay back any extra tax you’ve paid in your future income payments
No further payment (including regular payments) is taken within the tax year – complete form P55

How your pension income is taxed

Pension income, like employment income, has income tax deducted (at your marginal rate) as you receive it. From the 2024/25 tax year, income tax rates and bands for pension income, any state pension you're receiving, as well as income from any ongoing employment, are:

Tax rates and bands for taxpayers in England, Wales and Northern Ireland.

Band name	Taxable income	Income tax rate
Personal allowance*	Up to £12,570*	0%
Basic rate	£12,571 to £50,270	20%
Higher rate	£50,271 to £125,140	40%
Additional rate	Above £125,140	45%

Scottish tax rates and bands:

Band name	Taxable income	Income tax rate
Personal allowance	Up to £12,570*	0%
Starter rate	£12,571 to £14,876	19%
Basic rate	£14,877 to £26,561	20%
Intermediate rate	£26,562 to £43,662	21%
Higher rate	£43,663 to £75,000	42%
Advanced rate	£75,001 - £125,140	45%
Top rate	Above £125,140	48%

*The personal allowance is reduced by £1 for every £2 of income above £100,000. It can go down to zero.

Example (not if you live in Scotland):

If your taxable income is £60,000 and your personal allowance is £12,570:

You pay no tax on the first £12,570, 20% tax on the next £37,700, and 40% tax on the balance of £9,730.

£12,570 x 0% = £0

£37,700 x 20% = £7,540

£9,730 x 40% = £3,892

Total income tax due = £11,432.00

Annuities

When you buy an annuity, you can normally take up to 25% of your pension pot tax free. Your pension provider will use the rest of your pension pot to buy your annuity. Income tax will then be deducted from the annuity payments by your annuity provider, using the tax code provided by HMRC, just as an employer would do with a salary.

As annuity rates can change substantially and rapidly, there's no guarantee that when you do purchase an annuity the rates will be favourable. This could mean that your pension thereafter may be less than you hoped for.

Flexi-access drawdown

You can normally take up to 25% of your pension pot tax free and the rest of your pot can be used for flexi-access drawdown. Flexi-access drawdown lets you keep your pension pot invested, and choose a regular income and/or one-off cash payments. This gives you significant flexibility — you can start, stop or vary your payments to suit your needs and yearly tax position. When you take income withdrawals, your drawdown provider will deduct income tax from your income payments using the tax code provided by HMRC, just as an employer would do with a salary.

The level of income isn't guaranteed. Drawing income will reduce the value of your account. You may need to reduce your drawdown income in the future, in particular if investment performance isn't sufficient, or you live to a greater age than originally anticipated.

The level of income you take will need to be reviewed regularly.

Depending on the performance of your investments, the income you receive may be lower or higher than you could receive from an annuity.

The value of an investment, and any income you take from it, can fall as well as rise and isn't guaranteed. You may get back less than has been paid in.

The rules governing how much income you can take may change. This could mean income drawdown no longer meets your requirements.

Your money purchase annual allowance (MPAA)

It’s possible to continue paying into a pension scheme after you access your pension pot, but the tax limits may change if you do. So you’ll need to plan your actions carefully.

Accessing your pension pot triggers the money purchase annual allowance tax rules in a number of scenarios such as:

certain cash lump-sum payments, or
when you start taking income from a flexi-access drawdown pension.

This means you’ll have to pay a tax charge on contributions over £10,000 paid during the year to any money purchase pension(s) - for example, a personal pension. If you do flexibly access your pension pot, you must inform any other pension schemes to make sure you pay the right amount of tax. You should do this within 91 days of when your provider writes to you confirming you've triggered the MPAA, otherwise you may be liable to a penalty of up to £300. This could then increase by a daily penalty of up to £60.

Special rules apply in the tax year that the MPAA is triggered, and different rules apply to final salary pensions. Please speak to your financial adviser for more information, there may be a charge for this. You should speak to your financial adviser, if you have one, about your options before making any decisions. If you don't have a financial adviser you can visit Moneyhelper to find the right one for you.

We've outlined the tax treatment of pension and annuity income here, but remember you'll also need to pay tax on:

Employment and self-employment earnings
Money earned from investments
Rental income from a property you rent out

You’re responsible for paying tax on the income you get from these additional sources – this may involve filing a self-assessment tax return with HMRC. If you have income from multiple sources on top of your pension, working with an accountant can help ensure you’re paying the correct tax.

For more information on how you’ll be taxed in retirement, read the government’s income tax guide.

Pension Wise, a service from Moneyhelper, is a free and impartial government service offering guidance about your retirement options. This service is available online at MoneyHelper by phone on 0800 138 3944 or face to face by appointment.

Aegon Assist, our friendly, UK-based team of trained specialists are on hand to help if you don't have an adviser and need guidance on ways to begin accessing your pension or bringing your pension pots together.

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