The information contained within this blog is based on fact and is not advice with regards your pension investments. When giving tax planning advice around pensions, we work closely with financial advisers to ensure the right plan is put in place. We recommend speaking with your financial adviser before making any decisions on what to do with your pensions.
For those nearing retirement, planning how to make the most of your pension income is a priority. Therefore, understanding how to avoid paying tax on your pension is crucial for maximising your retirement funds. But it can be difficult to know where to start.
In this guide we will explore effective strategies to reduce your tax liability and ensure you retain more of your hard-earned savings. Whether you’re considering taking your pension as a lump sum or drawing a regular income, these tips can help. Partnering with our team of experts and chartered accountants at Kirkwood Wilson, we can also provide tailored tax planning advice to optimise your financial situation.
Do You Pay Tax on Pension Income?
In the UK, most pension income is subject to tax. After your tax-free allowance, any income from your pension is treated as taxable income. The tax-free allowance is known as the Personal Allowance, which, as of 2025, is £12,570 per year. Any pension income above this threshold is taxed according to the income tax bands:
- Basic rate: 20% for income up to £50,270.
- Higher rate: 40% for income between £50,271 and £125,140.
- Additional rate: 45% for income over £125,140.
One of our chartered accountants can help you navigate these thresholds and provide guidance on how to avoid paying unnecessary tax on your pension by carefully structuring your income streams.
How Much Tax Will I Pay on My Pension Lump Sum?
When accessing your pension, up to 25% of your pension pot can typically be withdrawn as a tax-free lump sum. However, whatever is left is considered taxable income. Depending on the size of your lump sum and any other income, you could find yourself pushed into a higher tax bracket for the year.
For example:
- If your pension pot is £200,000, you can withdraw up to £50,000 tax-free.
- If you withdraw an additional £50,000 in the same tax year, this amount will be taxed based on your marginal rate.
Strategies such as spreading withdrawals over several tax years can help reduce your overall tax liability. One of our tax planning professionals can analyse your financial situation and create a withdrawal strategy to minimise tax exposure.
How to Avoid Paying Tax on Your Pension
Reducing your pension tax liability requires careful planning. Here are some effective strategies that you could consider:
1. Utilise Your Personal Allowance
Ensure you make the most of your tax-free Personal Allowance. If your pension income is likely to exceed the threshold, consider drawing some income in years where your total taxable income is lower.
2. Split Withdrawals Across Tax Years
Taking large pension withdrawals in a single year can push you into a higher tax bracket. By spreading withdrawals over several years, you can keep your taxable income within a lower band. This approach is particularly useful if you’re supplementing your pension with other income sources.
3. Maximise Tax Reliefs
If you continue working part-time or have other taxable income, you may still be eligible for pension contributions. Contributions to a pension scheme attract tax relief, effectively reducing your taxable income for the year.
4. Leverage ISA Allowances
Individual Savings Accounts (ISAs) provide a tax-free way to grow your savings. By transferring some of your pension income into an ISA, you can shield future growth and withdrawals from tax.
5. Take Advantage of Tax-Free Lump Sum
Accessing your 25% tax-free lump sum strategically can make a significant difference. For instance, using the lump sum to pay down debt or invest in tax-efficient vehicles can help you reduce future income tax liabilities.
6. Consider Deferring Your State Pension
Deferring your State Pension can boost the amount you’ll receive later and reduce your taxable income in the meantime. Every year of deferral increases your pension payments when you eventually start claiming them.
7. Seek Professional Advice
Our team of chartered accountants can work with you individually to help identify bespoke strategies to optimise your tax position. They can also help you understand the complexities of the tax system and ensure you’re making the most of available allowances and reliefs.
Do HMRC Automatically Refund Overpaid Tax on Pension?
It’s common for individuals to overpay tax when withdrawing from their pension, particularly in the case of a large lump sum. HMRC often applies an emergency tax code, which assumes the withdrawal will be repeated regularly, potentially leading to higher deductions.
While HMRC may automatically refund overpaid tax at the end of the tax year, you don’t have to wait. You can claim back overpaid tax sooner by submitting a P55, P50Z, or P53Z form, depending on your circumstances. Our team can guide you through this process to ensure you reclaim any overpayments promptly.
Why Tax Planning is Essential
Tax planning isn’t just about saving money; it’s about securing peace of mind and ensuring your retirement income supports your desired lifestyle. By working with a chartered accountant, you can:
- Avoid costly mistakes and unnecessary tax bills.
- Optimise your withdrawals to stay within lower tax brackets.
- Gain clarity and confidence in managing your pension income.
For more information on understanding tax, how to avoid paying tax on your pension, and how to preserve your wealth during retirement, get in touch with our expert team today.
