How to Avoid Paying Tax on Your Pension?

  • January 4, 2024
  • January 8, 2024
  • Shaz Nawaz
  • 12 min read

Are you planning for your retirement? Then you may wonder if your state pension is subject to tax. Or if you need to pay tax on any of your pensions. Since the pension you receive falls under the category of income, you owe tax on it. It is important to understand the tax implications of pensions. This guide will cover everything you need to know about paying tax on your pension in the UK. You will also discover the ways to avoid paying tax on your pension.

First, let us discuss if you need to pay tax on your pension. Then, we can move on to more complex matters.

Do You Need to Pay Tax on Your Pension in the UK?

The short answer is yes, tax applies to your pension. It is subject to tax, like any other type of income.

However, everyone has a personal allowance on which they do not need to pay income tax. For the 2023/24 tax year, the allowance is £12,570.

If your income is between £12,571 to £50,270, then you pay 20% tax. Above this income, a higher rate tax of 40% applies. You pay 45% tax as an additional rate taxpayer when your income is over £125,140.

The good news is that there are certain situations in which you do not pay tax on all pension income. Moreover, you can use strategies to reduce the amount of your pension lost to tax.

How Much of Your Pension is Tax-Free?

Fortunately, a part of your pension is tax free. You can typically take 25% tax-free cash from your pension if you have a defined contribution pension. The remaining 75% is subject to tax as earnings.

This occurs by taking a quarter of the pot in one lump sum. You can also take a series of smaller lump sums. Each one is 25% tax-free.

Usually, this is done by taking a quarter of the pot in a single lump sum, but it is also possible to take a series of smaller lump sums, with 25% of each one being tax-free.

Let us look at an example to elaborate.

Suppose you have a pension pot of £80,000. You decide to take the whole pot. Then, only £20,000 is going to be tax free. You need to pay income tax on the remaining amount, which is £60,000. The option of taking a guaranteed taxable income along with a tax-free lump sum exists with most defined benefit pensions. For details, ask your scheme. To avoid a substantial tax bill, it is a wise move to get financial advice before you evaluate your pension. That is why it is important to know whether you can avoid paying tax on your pension.

Do You Need to Pay on Your State Pension?

State pension is subject to tax. However, your annual income determines whether you need to pay tax.

As you know, your annual allowance is £12,570, whereas the upper limit for the new state pension is approximately £10,600. Per week it is £203.85. Therefore, you do not pay any tax if the state pension is your only income.

On the other hand, if you have other sources of income then you owe tax on the amount that exceeds your annual allowance.

Here is an example to elaborate.

Suppose George has an annuity that pays him £9,000 a year and he gets the full new state pension. For the year, his total income amounts to £19,600. Now, let us deduct the annual allowance of £12,570. As a result, we get £7,030, which is taxed at 20%. Therefore, his income tax bill is £1,406.

How to Pay Tax on Your Pension

Using your tax code, your provider taxes your pension. At the time of withdrawal, it has already been taxed. You should know the methods to avoid paying tax on your pension.

Through Pay as You Earn (PAYE) they take off tax that you owe on your state pension.

Since emergency tax can apply to withdrawals, it is ideal to confirm that you paid the right amount of tax. You must reach out to HMRC to get a refund if this happens.

Does the Recipient Pay Tax if You Inherit Your Pension?

Suppose you inherit a personal pension. In this case, you may end up paying tax.

Certain factors determine whether you pax tax, such as the type of pension pot and payment you receive. The age of the person when they passed away is also a contributing factor.

After your passing, part of a state pension can be inherited in some situations.

How to Avoid Paying Tax on Your Pension

The only certain method to mitigate tax on your pension is to remain below the personal allowance. You must make sure that your total taxable non-savings income, which includes your pension income is below it. There is a drawback as you cannot have the standard of living of your choice in your retirement years.

Instead, here are a few tips to help you limit the amount of tax you owe on your pension:

Only Withdraw the Amount You Require Yearly

It is better to keep an eye on remaining within specific tax thresholds even though you can take out as much as you like. Certainly, everyone wishes to have enough to live a comfortable life. In the current tax year, if you take out up to £50,270 only, then you pay 20% income tax. If you exceed this amount, then you need to pay 40% income tax. Therefore, by remaining careful, you can stay within the threshold and pay less tax.

You do not need to draw down on your pension income to place into savings at the stage of retirement. Thus, withdrawing less to remain within a low tax range is more financially beneficial than withdrawing more and paying significantly more tax. Therefore, you must understand the ways to avoid paying tax on your pension.

Use a Drawdown Scheme to Your Advantage

With the help of drawdown, you can vary your income from year to year. This means that each year you can choose to keep it under a specific tax range. Nevertheless, this is not possible if you have an annuity. Unfortunately, you can not vary annuity income at will. Please note that there are certain risks with drawdown. Therefore, it is ideal to reach out to a financial adviser before you select an option.

Avoid Drawing your Pension All at Once

The above-mentioned points clarify that by staggering your pension to receive less annually will result in less tax. Although it is tempting to empty your pension pot all at once, you will have to pay income tax on it in one year. From a tax perspective, this is usually an unwise decision. This will lead to your income falling into the higher tax rate bands. As a result, you will end up paying a substantially larger tax bill.

Try to Phase Your 25% Tax Free Cash

You will need to pay 40% income tax on any amount that you draw over £50,270 from your pension. In this scenario, you can take smaller amounts from your tax-free cash. Then, when you reach these limits, you can use them to top up your income. With careful planning, you can use this brilliant retirement income strategy to make sure that you do not end up paying higher rates of income tax.

Is it Possible to Get a Tax Refund on Your Pension?

If an emergency tax rate applies to a lump sum withdrawal from your pension, then it is an overpayment of tax. In case this happens, you can get a refund. This requires you to contact HMRC or fill out a P53 or P53Z form.

Can You Work While Drawing Your Pension?

Yes, you can work and draw any type of pension. You earn an income and draw a personal, workplace, or state pension. However, you should understand that if you work while drawing your pension, your tax bill will increase. Make sure you know the methods to avoid paying tax on your pension.

How Much Tax Will You Pay on Your Pension While Working?

Since you will have the same tax bands and personal allowance, the normal tax rate will apply to income above £12,570. Which is at least 20%. However, if part of your non-pension income is from dividends, then different rates apply.

The amount you can pay in and get tax relief falls will probably fall if you start drawing your pension. This is called money purchase annual allowance (MPAA).

How Much Tax Do You Need to Pay on Your Pension Lump Sum?

It is possible to take 25% of any pension pot as a tax-free lump sum. The remaining 75% of the pension pot is subject to tax. Nevertheless, you can cash in a whole pension pot as one lump sum.

Please note that it is not a good idea to do so from a tax perspective. It is only worth considering if your pension pot is very small. The money you get counts as income for only that year and tax applies accordingly. If it puts you into a higher tax band, you will end up paying 40% or more. Thus, you must know the steps to avoid paying tax on your pension.

To sum up, by having pension you are likely to end up cancelling out any tax benefits.

You should only withdraw an entire pension pot when it is very small. For example, if you are receiving workplace pension from brief employment.

Still, it is probably better for you to transfer it to your main pension. As always, it is ideal to get expert financial advice.

What is Pension Tax Relief?

The government pays tax relief on pension contributions. They do so to encourage people to save for retirement. By claiming tax back from HMRC, your pension provider can add that amount to every contribution you make. According to your perspective, it is as if you are getting a bonus on everything you save.

Shaz Nawaz Explaining Pension Contributions & Taxes

How Does Pension Tax Relief Work in the UK?

There two main methods to get tax relief on your pension contributions. One is ‘relief at source and other is ‘net pay’.

Relief at Source

You will always receive tax relief via relief at source if you have a personal pension.

In this case, it is your employer that takes away tax from your salary. Then, they deduct your pension from your after-tax pay. Your pension provider will receive it.

Prior to placing it into your pension, your pension provider will claim 20% rate of tax relief from the government. This is the basic rate. You must claim extra tax relief from the HMRC in case you are higher or additional rate taxpayer. Whereas you need to contribute to your pension provider if you are self-employed. Hence, you should understand the strategies to avoid paying tax on your pension.

Net Pay

This differs from relief at source as they take your pension contribution before you are taxed. As a result, you pay less tax. Also, you do not need to claim any relief back as you get tax relief immediately. There is drawback of net pay. In this case, you do not get any tax relief if you do not pay tax.

Can You Get Tax Relief if You Do Not Pay Any Tax?

Now, what happens if you do not pay tax? Receiving tax relief on pension contributions is dependent upon the methods your employer chooses to use.

If your employer uses net pay method, you do not get any tax relief if you do not pay tax. With relief at source, you should get tax relief when you do not pay in more than your UK earnings. Therefore, you need to understand the means to avoid paying tax on your pension.

You should ask your employer to set up a workplace pension scheme if they do not have one already.

How to Calculate Tax Relief

The amount of tax relief you receive depends on the highest rate of income tax you pay. You will get 20% tax relief if you are a basic rate taxpayer.

To explain further, every pound you pay in turns to £1.25. If 20% tax applies to £1.25, then it becomes £1. Which means that if you get 20% tax relief it is equal to receiving a 25% boost to every contribution. Undoubtedly, this is a major reason other investments cannot compete with pensions.

How Much is the Tax Relief on Pension Contributions for Higher Earners?

You will receive 40% tax relief on pension contributions if you are higher-rate taxpayer. In this case, every pound turns to approximately £1.66. This is equivalent to a 66% boost to every contribution you make towards your pension.

As an additional rate taxpayer, you will receive 45% tax relief, which is an 80% boost.

Nevertheless, additional tax relief does not deliver automatically.

When it comes to basic 20% tax relief, it is added to each contribution. However, you need to claim back your extra tax relief through your tax return if you are a higher or additional rate taxpayer. It is essential to know whether you can avoid paying tax on your pension.


As someone who is planning for their retirement you should know how tax applies to your pension. Make sure you understand the tax thresholds so you can remain within them and avoid paying higher rates of tax. You also have a personal allowance, which is an amount of pension you can have free of tax. Although it is not likely for you to avoid paying tax on your pension, there are ways to reduce it. It is ideal to reach out for expert financial advice.

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