How does pension drawdown tax work?
Most modern workplace and personal pensions are defined contribution pensions.
You can currently access both of these pension types from the age of 55 (rising to 57 from 2028). There are a variety of ways to withdraw your retirement savings including pension drawdown.
Understanding exactly how pension drawdown works will ensure you don’t pay any more tax than you need to.
Understanding the basics of pension drawdown
Pension drawdown is a flexible way to take cash from your pension once you reach retirement age. You can choose to take this as one lump sum, or you can draw down in stages – either way 25% is tax-free. If you go over this 25% tax-free threshold, then the remaining 75% will be counted as earnings or income. This means anything you withdraw from your pension above the tax-free amount will be added to the rest of your taxable income for that year.
If you withdraw a large amount, it could push you into a higher tax band and towards a bigger tax bill. Being a higher rate taxpayer could affect your entitlement to State benefits, such as Universal Credit.
With this in mind, consider how much you need to take out of your pension, and when. You may be able to pay less tax if you spread out the amount you withdraw. It’s worth making a plan for your pension and how it’ll support you through your retirement. For more information, check the current income tax rates and personal allowances.
Let’s look at an example
Let’s say you want to draw down £60,000 from your pension. You’ve already taken your 25% tax-free cash and you don’t earn any other income that year, including any State Pension.
If you take this amount as one lump sum;
- you won’t pay any tax on your tax-free personal allowance up to £12,570;
- you’ll pay the basic rate of 20% tax on the amount between £12,571 and £50,270; and
- you’ll pay the higher rate of 40% on the final part between £50,271 and £60,000.
This means your total tax bill would be £11,432.
However, if instead you take £10,000 per year for six years, then you potentially won’t have any tax bill at all. This is because the amount of income you’d receive would come under your tax-free personal allowance each year.
You can use a Pension Drawdown Calculator to plan your withdrawals and get a clearer picture of the drawdown tax you may have to pay.
Can you still pay into a pension after you’ve withdrawn?
Yes, you can continue contributing to your pension after you’ve started withdrawing from it. This provides the benefits of essentially free money in the form of government tax relief. But, if you withdraw any taxable cash from your pension, then the amount you can pay into your pension is limited to £10,000 per year (based on tax year 2024/25). This is known as the money purchase annual allowance (MPAA) and it applies to all of your defined contribution pensions collectively, not per pot.
How is tax on pension withdrawals paid?
Your pension provider will usually remove any tax before a withdrawal is paid using Pay As You Earn (PAYE). When you take a taxable pension income for the first time, it’s likely that you’ll be taxed using either an emergency tax code or the tax code provided on a P45.
You should settle any remaining underpaid or overpaid tax directly with HMRC.
Risk warning As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.
About PensionBee
PensionBee can help you withdraw flexibly from your pension from the age of 55 (rising to 57 from 2028). You can take your pension flexibly online or through our PensionBee app via drawdown. For more information, visit PensionBee.com.
Start planning your pension withdrawals with the PensionBee Drawdown Calculator
Planning for retirement with PensionBee – Free webinar
PensionBee and Silversurfers are excited to bring you a free webinar packed full of pension knowledge. Join us online from 6-7pm on 24th June where we’ll be discussing retirement planning essentials, such as how much you need to retire and the ways in which you can access your pension.
Our panel of financial experts, Becky O’Connor, Director (VP) Public Affairs at PensionBee; Faith Archer, Founder of Much More With Less; and Pete Matthew, Chartered Financial Planner and CEO of Jacksons Wealth in Penzance, will be sharing tips and insights to leave you feeling more pension confident.
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Anything discussed in the webinar should not be regarded as financial advice and as always with investing, your capital is at risk.
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