Unfortunately, you may still be liable to pay income tax on all the same things as you did before you retired.

Retirement income and interest from some savings and investments are still seen as taxable income, so while the new pension rules give you more flexibility, you should make sure to manage your money in a tax efficient way.

Tax-free cash

One major benefit of a pension pot is that you can usually take up to 25% of it as tax-free cash, either in a lump sum or in stages, to suit your plans.

This means that if you decide to start taking an income from your pension pot you can, if you want, take up to 25% of your pension pot’s value as a one-off tax-free cash lump sum first.

Or if you’re taking your pot in smaller sums or payments, the first 25% of each cash withdrawal will be tax-free. You might choose to do this to minimise the tax you pay over time.

How your pension is taxed

As long as your pension pot remains invested, it's largely protected from tax. Once you start withdrawing it, it counts towards your income and is therefore taxable.

The tax you pay will depend on your total taxable income and any personal allowances you're eligible for. In the 2017-18 tax year, the standard personal allowance is £11,500; any income below this will be paid without any tax being deducted. HM Revenue & Customs should be able to confirm how much your personal allowance is.

If your total retirement income exceeds your personal allowance, you'll pay tax on the amount that exceeds your allowance. Different rates of income tax apply depending on the type of income and how much it is. The tax will normally be deducted at source by the provider of your retirement income and they'll pay HMRC on your behalf.

You need to be aware that, whilst the new pension freedoms give you more flexibility over how you can access your pension pot, if you take substantial amounts from your pension pot in any one year, you could become liable to pay higher rates of income tax up to 45%.

The example below shows how pension income can push you into a new tax bracket when added to your other earnings. It assumes earnings of £30,000 and a taxable pension income of £17,000. Therefore total taxable income (earnings + pension) is £47,000.
 

HOW THE TAX IS BROKEN DOWN AND CALCULATED
First £11,500  No tax First part of the £30,000 (non-pension) earnings
Next £33,500 taxed at 20%  £6,700 £18,500 comes from the remaining non-pension earnings (£30,000 less £11,500 = £18,500)
The remaining £15,000 comes from part of the £17,000 taxable pension income
Final £2,000 taxed at 40%  £800 Comes from the remaining taxable pension pot income (£17,000 less £15,000)
Total tax paid  £7,500  

 
THE TAX PAID ON THE PENSION INCOME PART OF TOTAL TAXABLE INCOME
£15,000 taxed at 20% £3,000
£2,000 taxed at 40% £800
Total tax paid on pension income £3,800

Please note, the income tax rates and bands for Scottish residents may be different.


It may possible to pay less tax by spreading your withdrawals over more than one tax year. You can read more about the potential implications of taking your pension savings in one go on our Thinking of taking cash page 

Given the number of options, we strongly recommend you seek guidance and/or financial advice before coming to a decision. You'll find descriptions of some of the services available on our How to Choose page.

If your pension provider doesn’t have up-to-date tax details for you, it's possible that they will deduct too much tax, or not enough. HMRC will automatically check the amount of tax you’ve paid at the end of each tax year and let you know if the amount isn’t right. If you think you've paid too much tax and don’t want to wait until the end of the tax year for a refund, you can contact HMRC directly. Details on how to claim back tax can be found at GOV.uk.

Your next steps

Or move on to the next section

Retirement Options which looks at the different ways you can access your pension pot.