Terms explained

You can use some, or all, of your retirement savings to buy an annuity, usually taking up to 25% of the amount selected as a tax-free cash sum. An annuity gives you a guaranteed income for life, or for a set number of years, depending on the type of annuity you buy.

Types of annuity

• A Lifetime Annuity will pay you a guaranteed income for the rest of your life
• A Flexible Annuity will allow you to vary your income, perhaps a larger amount now, and a smaller one later on
• A Fixed Term Annuity will provide you with a guaranteed income for a set number of years only

You can also add other options like a pension for your spouse, partner or other financial dependants that will continue to be paid if you die before them. You could also choose your payments to increase each year, for example in line with inflation, or remain the same. Annuities can also be paid monthly, quarterly or even annually.

The income you get from an annuity is taxable and the amount of income your retirement savings could buy might vary significantly. If you have any health or medical conditions, or relevant lifestyle factors such as smoking you may be entitled to a higher annuity income. No single provider offers the best rate in all circumstances so it is important you shop around to choose the best option for you. Even if you don’t qualify for a higher income with one annuity provider, you might with others.

Although there is no maximum you can pay in to a pension, the government has put in place an ‘Annual Allowance’ which includes any money that you pay in and any money that an employer pays in on your behalf, to this plan or any other pension plans you may have.

If you exceed the Annual Allowance you’ll pay tax on any amount paid above it, even if that amount was paid in by someone else.

For high earners the Annual Allowance is reduced when their annual income is over £200,000.

When you decide to access your pension savings your Annual Allowance may be reduced depending on the options you choose. This is called the Money Purchase Annual Allowance (MPAA).

These allowances can change with each new tax year, depending on what the government sets out. Download our Tax Year Rates and Allowances booklet to keep up to date on what these allowances are, and how they could affect you.

You can take some or all of your pension pot as a cash lump sum from age 55. Normally 25% of each lump sum you take will be paid tax-free and the remainder will be taxable as income.

Drawdown is a way of taking a taxable income from your pension pot. Historically the amount that most people were able to take in this way was limited to a percentage of an estimated annuity that's calculated using government rates.

Since April 2015 people have had more freedom about how and when they can take an income direct from their pension pot. Whilst any existing capped drawdown can continue beyond 6 April 2015, anyone wishing to start drawdown from this date will be taking flexi-access drawdown.

Flexi-access drawdown is a way of taking an income from your pension fund pot without having to buy a pension annuity. Pension freedoms introduced in April 2015 have given people more flexibility over how much they can draw down from their pension pot from age 55. Income is taxable and can be taken on a regular or occasional basis with the rest of your pot remaining invested.

Not all pension schemes and providers offer flexi-access drawdown and those that do are likely to charge to use the facility and may have a minimum pot size requirement. You have the right to transfer your pot to another scheme or provider.

Any amount you personally pay into a pension scheme is free of income tax as long as it’s within 100% of your annual earnings, and within the annual allowance.

This is called income tax relief, and the amount you are entitled to will depend on the rate of tax you pay and may also depend on which country you live in within the UK. The way this works will be set by your employer and depends on the type of scheme, as the government offers two choices:

Relief at source

This is where your employer deducts your contribution from your earnings after tax, and your pension scheme gives you back tax at the basic rate.

For example, if you have agreed to pay £100 a month (gross) into your pension, you only need to pay £80 from your take home pay.

Your scheme will then add £20 to this (using the current basic rate of income tax of 20%) bringing the total to £100.

If you pay tax at a higher rate, you'll need to claim the rest back on your self-assessment return as the scheme is not allowed to claim back more than the basic rate.

However, if you don’t pay income tax because you’re on a low income, you will still get income tax relief on anything you pay up to 100% of your earnings each tax year, or £3,600 (gross) if this is more.

Net pay

Under this method, your employer will take your contributions from your gross salary before any tax is paid. Because of this, you will automatically benefit from tax relief at your highest rate straight away.

If you don’t pay income tax because you’re on a low income, you can still get income tax relief on anything you pay up to 100% of your earnings each tax year, or £3,600 (gross) if this is more but this is not automatic.

If you are eligible you can receive a Joint State Pension from the government at State Pension Age, if you are married or in a registered civil partnership.

When you access your pension, you can usually take up to 25% of it as a tax-free lump sum.

Your ‘Lump Sum Allowance’ is the maximum amount of money you can take as tax-free lump sums from all the pensions you have. While you can still take out money over this allowance, you will need to pay income tax on it. The Lump Sum Allowance is £268,275. It will be higher if you have any protected tax-free lump sums, or a protected lifetime allowance

Your ‘Lump Sum Death Benefit Allowance’ (LSDBA) is the total amount of tax-free money you can take across all the pensions you have as a:

• tax-free lump sum
• tax-free serious ill-health lump sum, paid out before you turn 75, or
• tax-free lump sum death benefit, paid out if you pass away before you turn 75.

The LSDBA is £1,073,100 . It will be higher if you have any protected tax-free lump sums, or a protected lifetime allowance. Income tax will need to be paid on any funds paid above the LSDBA, by whoever receives the payment

Please see ‘Defined Contribution (Pension) Scheme.

Pension Credit is an income-related benefit made up of two parts - Guarantee Credit and Savings Credit.

• Guarantee Credit tops up your weekly income if it’s below a certain level.

• Savings Credit is an extra payment for people who saved some money towards their retirement, for example a pension.

Find out more about Pension CreditOpens in new tab.

Government regulations about defined contribution pension schemes mean people have more freedom over how they can access their pension pot.

You can normally take up to 25% of your pension pot as a tax-free lump sum and with the remaining 75% you can:

• Take a lump sum which will be taxed as income or;
• Leave it invested and take regular or occasional amounts that will be taxed as income or;
• Buy an annuity. An annuity will provide you with a guaranteed income, either for life or a fixed term, which will be taxed as income.

From age 55, you can choose how and when to access your pot, including using a combination of the above options. Your pot will remain invested until it has been used up or transferred to another provider. Different providers will offer different options, features, rates of payment, terms and charges.

When you come to access your pension pot, free and impartial guidance is available to you from an independent government service called Pension Wise.

Visit the Pension Wise websiteOpens in new tab.

If you are eligible you can receive the Basic State Pension from the government when you reach State Pension age. Your State Pension age will depend on your date of birth. 

Find out more information on the State Pension and State Pension age. The Additional State Pension has been replaced with a single flat rate State Pension for people reaching their State Pension age on or after 6 April 2016. It was only available to people who were in employment  and the amount depends on your earnings while you are employed, and the national insurance contributions you've paid.

It is also often called the State Second Pension and was previously known as the State Earnings Related Pension Scheme (SERPS). The government has announced that the Additional State Pension will stop for people reaching State Pension Age and be replaced with a single flat rate State Pension after 6 April 2016.

Find out more about the Additional State PensionOpens in new tab.

The tax year runs from 6 April to 5 April of the following year.