Pensions
Understanding tax on your pension
4 min read 18 Dec 24
Please see our glossary for information on the financial terms used in this article.
Preparing for retirement can be a complex process, and many of us don’t appreciate how important it is to have a plan in place early on. Pensions are an important tool for building your savings, and one of the key considerations when growing your pot comes from managing your pension in a tax-efficient way. The way you contribute to and withdraw from your pension can significantly impact how much tax you pay. In this article, we’ll explore the relationship between pensions and taxes.
Remember that everyone’s personal financial circumstances are different and this article does not constitute advice. Speak to an expert on how to manage your retirement fund and maximise tax efficiencies in a way that is suitable for you.
Before diving deeper into pension strategies, it’s helpful to define some key terms:
- Contributions: Payments made into a pension plan, which can come from multiple sources, including the employee, employer, and the Government.
- Growth: The increase in the value of a pension over time. Growth can occur through continued contributions, asset appreciation, and investment performance.
- Withdrawals: The methods by which you can take money out of your pension, including drawdowns, lump sum payments, and annuities.
- Tax-free cash: Many pension schemes allow you to withdraw up to 25% of your pension pot as a tax-free lump sum.
Tax-efficient saving
One of the key benefits of pensions is their tax efficiency. When you contribute to a pension, you benefit from pension tax relief, which means that part of the money that would have otherwise gone to the Government as tax instead goes into your pension. This tax relief can help reduce your overall tax liability and, over time, can substantially boost your retirement savings.
Different types of pensions come with various tax rules. For instance, workplace pensions typically involve employer contributions, and you might also be entitled to Government contributions, depending on the type of pension. This makes pensions a powerful tool for long-term, tax-efficient saving.
How your pension income is taxed
Once you begin drawing on your pension, it's important to understand how your pension income is taxed. The key to this is your Personal Allowance, which is the amount of income you can earn each year without having to pay tax. For the 2024/2025 tax year, the Personal Allowance stands at £12,570, but it can vary depending on personal circumstances.
Your Personal Allowance is made up of several types of income, including:
- Earnings from employment
- Any taxable benefits you are entitled to
- Private pensions (though up to 25% can be taken tax-free)
- The State Pension and any Additional State Pension entitlement
- Other income, such as savings and investments
If your total income from these sources exceeds your Personal Allowance, the excess will be subject to tax. It’s also worth noting that tax rules can change, so it’s always important to stay informed and seek advice from experts to make sure you're managing your pension in the most tax-efficient way possible.
Why not let experts help you navigate tax and pensions
Planning for retirement can be daunting, especially when it comes to understanding the tax implications of your pension. However, expert advice can ensure that your pension works as hard for you as possible, helping you to maximise your income in retirement while minimising your tax liabilities.
If you don’t already have an adviser you can find a financial adviser that's right for you. Visit our ‘Get financial advice’ page to find out more.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to your financial adviser. The views expressed here should not be taken as a recommendation, advice or forecast.