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What is the tax applied to pension drawdown?

A guide to pension drawdown and how it is treated for tax purposes.

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By Tony Stevens  | Pensions Expert

Updated: 29th August 2019 *

We receive lots of enquiries from people who want to understand how their pension drawdown is treated for tax purposes and also how much tax-free cash can be taken from a pension drawdown fund.

To answer these questions, and more, we’ve produced this comprehensive guide to explain how tax on pension drawdown works. The guide will cover the following areas:

For more information about pension drawdown and tax, call us on 0808 189 2301 or make an enquiry. We'll then match you with one of the expert advisors we work with to discuss your circumstances.

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How does tax work on pension drawdown?

From the age of 55 onwards anyone who has contributed to a personal pension (known as a defined contribution or money purchase scheme) is allowed to drawdown income from their pension fund if they wish.

Once you start taking your pension drawdown you need to be aware that you may be liable for income tax on your drawdown payments. The amount of your tax liability depends on how much drawdown you receive during the tax year.

Who is liable for paying tax on their pension drawdown?

If you are resident in the UK and claiming your pension drawdown you are liable for income tax on any amount in excess of your personal income tax allowance.

Any income from your pension drawdown is taxed at source by your pension provider using a pay as you earn (PAYE) system. If you know your tax code it is best to inform your provider before taking any withdrawals to avoid any overpayment of taxation on your pension drawdown. Make an enquiry to speak with an advisor for more information.

How much can I drawdown from my pension tax free?

You are allowed to withdraw 25% tax-free from your total pension drawdown fund with the remaining 75% available for income drawdown which could be liable for tax at your marginal rate.

For example, if your pension pot was worth £200,000 then you could take up to £50,000 as a 25% tax-free lump sum from your pension drawdown at the outset. It cannot be taken in full at a later stage and does not interfere with your personal income tax allowance.

The sections below outline, in more detail, how the pension drawdown tax rules work.

How much tax could I be liable for on income pension?

The amount of tax you could be liable for depends on how much drawdown pension you receive during the fiscal year. There are two pension drawdown options available:

  • Flexi-access drawdown
  • Uncrystallised Fund Pension Lump Sum (UFPLS)

If you want to take your full 25% tax-free cash at outset from your pension drawdown you should opt for the flexi-access option. If you’d like to spread the 25% tax-free sum out with each drawdown payment you should use the UFPLS option.

To find out how much tax you could be liable for on your income pension, make an enquiry.

Tax on flexi-access drawdown

For flexi-access drawdowns the remaining 75% can be taken as a regular income - monthly/quarterly/bi-annually or annually. Alternatively you can take ad hoc payments as and when required or just take it all out at the same time as your tax-free lump sum.

How you decide to drawdown your pension income will dictate how much income tax you may be liable for. For example, if you have a pension pot worth £100,000 and you decide to take it all out at the same time using flexi-access drawdown, £25,000 will be tax-free and the remaining £75,000 will be liable for income tax at your marginal rate.

Tax on UFPLS

If you use the UFPLS option for your pension income then 75% of whatever drawdown payment you receive will be liable for taxation at your marginal rate. For example, if you drawdown £1,000 per month the first £250 will be tax-free and the remaining £750 may be liable for income tax.

The next section illustrates how your pension income could be taxed using some practical examples.

Examples of how drawdown pension is taxed

As outlined above, any drawdown payments in excess of the 25% tax-free sum could be liable for UK income tax at your marginal rate.

If your drawdown pension is your only source of income and it does not exceed your personal income tax allowance then no tax will be due. Any pension drawdown amounts in excess of your tax free allowance will be liable at your marginal rate.

Here are some examples of how this works:

Taking the whole pension fund as one lump sum

Using the example above, if you had a pension fund of £100,000 and you wanted to take it all out at once using flexi-access drawdown the table below shows how much tax would be liable (assuming there are no other sources of taxable income):

Pension Fund 25% Tax-Free sum Amount liable for income tax Amount after tax allowance Amount taxed @ 20% Amount taxed @ 40% Total tax liability
£100,000 £25,000 £75,000 £62,500 £37,500 £25,000 £17,500

*using 2019/2020 tax bands and rates for single person

Unless it’s required all at once, this may not be the most tax efficient way to take your pension drawdown. Spreading your drawdown payments over a number of tax years could potentially reduce your tax liability.

Spreading your pension drawdown payments

The table below uses the same pension fund but this time using a pension drawdown amount of £15,000 during the year. Again, this uses pension drawdown as the only source of income:

Pension Fund 25% Tax-Free sum Pension Drawdown Amount after tax allowance Amount taxed @ 20% Total tax liability
£100,000 £25,000 £15,000 £3,150 £3,150 £630

If you assume the remaining pension fund (£75,000) has no investment growth at all this income would last for five years. On this basis the total income tax over this period would equate to £3,150 (in reality it would likely be less as tax allowances increase).

As you can see it is much more tax efficient to spread your pension drawdown payments out over a number of tax years rather than taking it all at the same time if this can be avoided.

These illustrations are for example purposes only. It is better to seek professional tax advice before proceeding with your pension drawdown - this is where we can help.

If you make an enquiry we can make sure an advisor we work with can make contact and talk you how tax on your pension drawdown could work out and help you decide how best to set up your retirement income.

What is a pension drawdown tax calculator and how does it work?

A pension drawdown tax calculator, in the UK, is a tool that can be used by either a pension provider or tax advisor in order to work out how much income tax may be liable for a particular drawdown payment.

You can use Pension Wise's calculator to get a rough idea of tax charges on your pension drawdown.

Frequently asked questions

Got a question about pension drawdown that we haven't answered yet? See below for more information, or send us a message with your query.

Could I incur emergency tax on my pension drawdown?

Yes, its possible. This is because pension drawdown tax payments are collected at source by your pension provider. When first set up they may need to use an emergency tax code which could mean you pay more tax on your pension income than is necessary.

If this happens - don’t panic! You can reclaim the overpaid tax back on your pension drawdown using either a P55, P50Z or P53Z form (you can find all of these forms online). Once you’ve submitted this form your money should be refunded within a matter of weeks.

HMRC will eventually recredit the money anyway but this will take longer. You can also avoid this by informing your pension provider of your tax code for the year (if you know it) in advance.

If all this seems a little complex, get in touch with us and we can arrange for a pensions specialist to show you how to claim back tax on your pension drawdown.

Is my income drawdown taxable in the UK if I live abroad?

If you move abroad and are no longer classed as UK resident for tax purposes you don’t usually pay UK tax on a pension drawdown. However, you may be liable to pay income tax in the country where you now reside and you should seek the advice of a local tax advisor to check this.

If you reside in a country with no double taxation agreement with the UK you may be liable for tax in both countries. To be sure its best to check HMRC’s website for further information.

Can I claim tax credits and pension drawdown at the same time?

Yes you can continue to claim tax credits whilst in receipt of pension drawdown. However, as pension drawdown is classed as earned income you need to inform HMRC of this income so they can properly assess what level of tax credits you are entitled to.

Do I pay inheritance tax on pension drawdown?

You are not usually liable for inheritance tax on any pension drawdown payment.

Do I pay capital gains tax (CGT) on income drawdown?

Your pension drawdown payments are not liable to capital gains tax as they are not classed as a sale of assets.

Speak to an expert on pension drawdown tax

If you have questions and want to speak to an expert for the right advice, call us on 0808 189 2301 or make an enquiry.

Updated: 29th August 2019
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*Based on our research, the content contained in this article is accurate as of most recent time of writing. Lender criteria and policies change regularly so speak to one of the advisors we work with to confirm the most accurate up to date information. The info on the site is not tailored advice to each individual reader, and as such does not constitute financial advice. All advisors working with us are fully qualified to provide mortgage advice and work only for firms who are authorised and regulated by the Financial Conduct Authority. They will offer any advice specific to you and your needs. Some types of buy to let mortgages are not regulated by the FCA. Think carefully before securing other debts against your home. As a mortgage is secured against your home, it may be repossessed if you do not keep up with repayments on your mortgage. Equity released from your home will also be secured against it.

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