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How does pension tax work?

pension review

Today we’re going to be covering the dreaded T word: Tax! It’s something we all have to pay, and something we all dread to think about when we look at our income and outgoings. Especially as you head towards retirement age, you might find yourself googling ‘how to avoid paying tax on your pension’.  

There are lots of nuances that surround how pension tax works, and what the rates are. So, let’s get into the nitty gritty.  

How are pensions taxed? 

When you start withdrawing from your pension the money is taxed in a similar way to income, i.e. through PAYE. You will pay income tax on your pension income, but not national insurance. However, there are allowances on your pension for what you can take from your pension without being taxed.  

  • Usually, 25% of your personal pension is tax-free, up to a maximum of £268,275 (this can vary depending on withdrawal method). 

  • Once you have taken your tax-free amount, you won’t pay tax on up to £12,570 of your income per year. 

It's also important to note that your 25% may not always need to be taken as one lump sum. If your pension policy rules allow it, you can take your 25% over time.  

State pension vs private pension   

Both state pension and private pensions are considered to be income – so they’ll both be taxed! However, you do have a personal allowance before you’re taxed, so if you earn less than the thresholds outlined above then you won’t pay tax. Current state pensions rates are below the tax thresholds so if you’re not receiving any additional income then this could be tax free.  

How much tax do you pay on pensions?  

Pension tax works much in the same way that employment tax does, so is on a scale depending on how much income you receive.  

You have a personal tax allowance (£12,570 for the 24/25 year) on which you pay no income tax. Then you pay 20% tax on income of between £12,571 to £50,270 and 40% on over £50,271. If you earn over £125,140, you pay 45% tax as an additional rate taxpayer.  

How to avoid paying tax on your pension? 

The only way to pay no tax on your pension would be to live below the above thresholds, which would mean a low level of income throughout your retirement years. However, there are a few ways to limit how much tax you pay.  

  1. Don’t take more than you need. Once you hit the higher earning threshold you have to pay a higher tax rate, so if you’re able to live in the lower tax brackets then you could do so. 

  2. Don’t take your full pension out in one go. If you take your pension over multiple years you can benefit from each set of yearly allowances, which can ultimately mean less tax paid.  

  3. Spread out your 25% tax free drawdown. If your pension policy rules allow it, you can use your available tax-free money to top up your income and stay below a certain tax threshold.   

How Reeves can help!  

If you’re still scratching your brain thinking about how to avoid paying pension tax then it’s time to get in touch with us today to undergo a free financial review. How it works is: we work together to go through your retirement goals, review your financials and come up with a plan on how you could get the most out of your money… and we do all of this without you paying a penny! If you then come onboard as a client of Reeves, we can manage your drawdown to ensure you are always paid in the most tax-efficient manner. Our bespoke tax-planning solutions will ensure your money is kept with you or your family instead of the pockets of HMRC.

If you think our planning could work for you, then come onboard and we’ll help you have a brighter financial future.  



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