What is pension tax?

You pay income tax on your pension, but only if:

  1. You are withdrawing more than 25% of your pension fund

  2. Your annual income, including your pension withdrawal, is over 11,000

  3. Your annual income, including your monthly pension, is over 11,000

If your annual income is over 11,000 you pay income tax on your pension when you start getting it monthly, including the State Pension and your workplace pension.

How much tax do you pay on your pension?

You have income tax deducted from your pension as you would for any other form of income.

The exception is if your annual income is under 11,000, then you will not pay any tax on your pension.

During the 2016/17 tax year, you would pay the following tax depending on your earnings for the year:

Annual earningsType of taxpayerTax deducted
11,000 - 43,000Basic rate20%
43,001 - 150,000Higher rate40%
Over 150,000Additional rate45%

Is your lump sum withdrawal taxed?

When you reach your retirement age you get the option to make a one off withdrawal worth 25% of your entire pension fund.

This withdrawal is tax free, meaning you get the full amount without any deductions.

Any withdrawals that exceed 25% of your pension fund will have income tax deducted.

For example, if you withdraw 60,000 (60%) from your 100,000 pension fund, you pay income tax on 35,000 (the amount above your 25% tax free withdrawal).

Is it better to withdraw all of your pension?

No, making a large withdrawal could force you into a higher income tax bracket for the year.

You could keep yourself in a lower income tax bracket by:

  • Withdrawing your 25% tax free lump sum

  • Spreading the rest of your pension over your retirement

Speak to an independent financial adviser before making a decision, as you may not have enough to live on in the future if you withdraw too much from your pension.

Are your pension contributions taxed?

The government gives you an annual allowance that means you get a 20% tax relief on the first 40,000 you pay into your pension each year.

This means you get the income tax back after it is deducted from your pay each month.

For example, a contribution of 100 a month will be raised to 125 when the tax relief is given; the amount you would have contributed before tax was originally taken.

However, you can only contribute up to the value of your annual salary each year, or 3,600, whichever is higher.

Can you build up your pension allowance?

Yes, you may be able to carry forward unused allowances from the previous three tax years.

Your pension allowance for the last few years were:

Tax yearAnnual allowance
2015/1640,000
2014/1540,000
2013/1450,000

To find out how much unused allowance you had from the last three tax years, contact your pension supplier or speak to an independent financial adviser.

What happens if you go over the limit?

You will not get any tax relief on any contributions over 40,000 a year.

For example, if you pay 60,000 into your pension during the same tax year, you will be taxed on 20,000 (60,000 minus 40,000).

If you think you could exceed your pension contributions limit for the year, speak to an independent financial adviser to discuss an alternative way to save towards your retirement.

How are pensions taxed when you die?

This depends on how old you are when you die:

  • If you are under 75, or have yet to touch your pension, it can be passed on tax free.

  • If you are over 75, whoever inherits your pension will pay income tax on it.