How does tax on pension savings work?
When you are building up savings…
You won’t usually have to pay tax as you save into a pension unless the total amount saved into the HRP over the tax year exceeds the Annual Allowance.
This means that saving into a pension arrangement is usually tax efficient, as you receive tax relief at your highest marginal rate of income tax.
For example, if you are a basic rate tax payer, for every £100 you save into a pension, this only costs you £80.
Plan contributions are usually paid through salary sacrifice, which means they are paid before tax (although changes are due to be introduced with effect from 6 April 2029). You can read more in your Plan booklet.
When you retire
At retirement you can generally take up to 25% of your pension pot as a tax-free lump sum (no income or capital gains tax).
However, the amount of tax-free cash that can be taken from all pension arrangements is typically limited to the Lump Sum Allowance (currently £268,275). This equates to 25% of the old Lifetime Allowance (LTA). Some exceptions apply, for example, if you have Lifetime Allowance protection.
Historically, funds drawn from your pension in excess of the LTA were subject to an LTA charge of 55% whereas, the lump sum allowance now means they are treated as income so taxed at your marginal rate of income tax).
When you’re drawing a retirement income
Once you have taken any tax-free cash at retirement, the remainder of your retirement income will be taxed at your marginal rate of income tax as you receive it.
This works in a similar way to the tax you currently pay on your employment income, except you won’t have to pay any National Insurance Contributions.
If you are spreading your tax-free cash by taking 25% of each payment tax-free, then any amount above this on each payment will be taxed at your marginal rate of income tax.
What are the Allowances?
The tax allowances which apply to pension savings are the Annual Allowance, the Lump Sum Allowance, the Lump sum and death benefit allowance, and the Money Purchase Annual Allowance.
If you exceed any of these allowances then you may need to pay additional tax charges. Remember these allowances are set by the Government and subject to change. If you’re not sure on whether any of these allowances apply to you, we recommend you discuss this with an FCA registered financial adviser.
Annual Allowance
The Annual Allowance (AA) is the maximum amount of pension savings that can be built up in a tax year before a tax charge may apply. This includes contributions paid by you and your employer.
For most people, the Annual Allowance is set by the Government and may change over time. Currently, it is £60,000 per year (2026/27). Some individuals may have a lower allowance, for example if they are high earners (typically with incomes over £200,000) and are subject to the tapered Annual Allowance. If the value of your pension savings exceeds your available Annual Allowance, you may have to pay an Annual Allowance tax charge. This is charged at your marginal rate of income tax.
It is your responsibility to check whether the Annual Allowance affects you. If you think you may be close to the limit, you should consider taking independent financial advice. For the latest Annual Allowance information and current limits, visit the Government website.
Lump Sum Allowance and Death Benefit Allowance
The Lifetime Allowance for pensions was abolished from 6 April 2024, however, new Lump Sum allowances were introduced:
- The Lump Sum Allowance (LSA) is the maximum tax-free cash lump sum you can take at retirement across all pension arrangements. This is currently £268,275. Each time a tax-free lump sum is taken, it reduces the LSA available for future use. Any excess lump sum over the LSA will be subject to your marginal rate of income tax.
- The Lump sum and death benefit allowance (LSDBA) is the maximum tax-free lump sums payable at retirement or on serious ill-health and certain lump sump death benefits payable to your beneficiaries. This is currently £1,073,100 and any tax-free lump sum death benefits over this allowance will be subject to income tax, paid at the beneficiary’s marginal rate of tax.
Money Purchase Annual Allowance
The Money Purchase Annual Allowance (MPAA) applies once you have accessed your pension savings ‘flexibly’ and taken a taxable income. This includes taking taxable income from a drawdown account, as well as the taxable part of a cash lump sum, known as an Uncrystallised Funds Pension Lump Sum or UFPLS. It doesn’t apply if you buy an annuity or if you take a small pot lump sum.
Once the MPAA is triggered, this restricts the amount of pension savings you (and your employer) can make into a money purchase (defined contribution) pension arrangement each tax year without incurring a tax charge. For the latest information and MPAA figures, please visit this Government website
You will need to make sure that you tell any other defined contribution pension arrangements that you are continuing to save into that you are subject to the MPAA so that they can assess your contributions against this lower level.
To assist you with this notification, your pension provider should send you a ‘flexible-access statement’ within 31 days of you first taking a taxable withdrawal. You will then need to let your other pension providers know within 13 weeks of receiving your ‘flexible-access statement’, otherwise you may be subject to a fine.
Therefore, if you are planning to continue working and/or saving into a pension arrangement after taking any of your pension savings, you should take the MPAA into account when deciding which option to take.
You can check if your contributions are above the money purchase allowance by using this calculator provided by HMRC.
What tax will my dependants pay on my death?
The amount of tax your dependants pay depends on how you take your pension savings and how old you are when you pass away.
| If you die… | Annuity | Drawdown | Cash |
|---|---|---|---|
| If you die…Before age 75 | AnnuityIf you have bought a joint annuity, which includes a regular income for your dependant following your death, they will receive their income tax free for the rest of their life. | DrawdownWith effect from 6 April 2027, any remaining savings in your fund may be subject to Inheritance Tax. | CashAny cash remaining from your pension savings that you have taken as a cash lump sum will form part of your estate for inheritance purposes. |
| If you die…Age 75 or over | AnnuityIf you have bought a joint annuity, which includes a regular income for your dependants following your death, they will receive their income for the rest of their life and will be taxed at their marginal rate of income tax. | DrawdownYour dependants will pay tax at their marginal rate of income tax, whether the account is paid as a lump sum or a regular income. | CashAny cash remaining from your cash lump sum will form part of your estate for inheritance purposes. |