How is your pension taxed?
When you retire you could end up paying tax on any money you withdraw from your pension. Here is how tax will affect your pension.
Pensions are long term investments. You may get back less than you originally paid in because your capital is not guaranteed and charges may apply.
What is pension tax?
You pay income tax on your pension, but only if:
You are withdrawing more than 25% of your pension fund
Your annual income, including your pension withdrawal, is over £12,500
Your annual income, including your monthly pension, is over £12,500
If your annual income is over £12,500 you pay income tax on your pension when you start getting it monthly, including the State Pension and your workplace pension.
When you withdraw from your pension the income tax is deducted automatically by your pension supplier.
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 £12,500 then you will not pay any tax on your pension.
During the 2020/21 tax year, you would pay the following tax depending on your earnings for the year:
| Annual earnings | Type of taxpayer | Tax deducted |
|---|---|---|
| £12,501 - £50,000 | Basic rate | 20% |
| £50,001 - £150,000 | Higher rate | 40% |
| Over £150,000 | Additional rate | 45% |
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 £34,500 (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.
Yes, but only 20% tax relief is automatically given by the government.
You will need to complete a self assessment form to claim back the extra 20% or 25% tax deductions, depending on whether you are a higher or additional rate taxpayer.
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 year | Annual allowance |
|---|---|
| 2019/20 | £40,000 |
| 2018/19 | £40,000 |
| 2017/18 | £40,000 |
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.
You can help ensure you have the retirement you want by finding the best personal pension plan to make your money work as hard as it can.