Want to avoid paying too much tax on your pension pot? Here are three things you could do

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Your pension pot (or pots) needs to last you a long time, so it’s normal to want to avoid paying more tax on it than you need to. It would be difficult to avoid paying tax completely, but here are three things you can do to keep the tax you pay to a minimum.

How much tax will I pay on my pension pots?

Let’s start with a quick overview of how any pension pots you have are taxed. We’ll keep this brief, but if you want a more detailed breakdown, read How much tax will I pay on my pension withdrawals? 

First thing to note is that most people will get 25% of their pension pot tax-free, and the remaining 75% is taxable. The amount of tax you pay on that 75% will depend on things like your tax code, the amount you take at a time and whether you have any income from elsewhere or not. Don’t forget, the total amount you can normally take tax-free across all your pension pots is £268,275, unless you have specific protections in place.

And remember, most people can’t access their pension pots until they reach age 55 (rising to 57 on 6 April 2028).

Keep in mind everyone gets a tax-free Personal Allowance every tax year, in the same way you do when working. For the 2024/25 tax year, the Personal Allowance is £12,570, and it’s been frozen at that level for a few years now. Anything you take above this amount will be taxed as earned income according to your tax band. 

Now let’s get into the tips.

1. Work with your Personal Allowance

The simplest way to avoid paying too much tax is to make sure you don’t take any more from a pension pot than you need to. Taking it in small, regular chunks could keep your tax bill down.

Remember, you only pay income tax on anything over your Personal Allowance. So, if a pension pot is your only source of income, you could take £12,570 from it each tax year and not pay any tax on it at all. 

On the other hand, if you were to take multiple large lump sums from your pot in the same tax year (outside of your 25% tax-free entitlement), you could potentially find yourself pushed into a higher tax bracket.

2. Combine tax-free with taxable

Like we said earlier, most people will get 25% of their pension pot tax-free and the remaining 75% is taxable. But the key thing to remember is you don’t necessarily need to take all of your tax-free lump sum in one go. You can usually take it in chunks over a number of months or years – as long the type of pension plan you have lets you do this.

So you could choose to take a withdrawal from the taxable portion of your pot, and top it up with some of your tax-free amount. In theory, every month, you could take £1,000 from the taxable part of your pot (staying under your £12,570 personal allowance) and £1,000 from your tax-free part. That would give you an income of £2,000 each month without paying any tax at all. This is just an example – you can usually switch up the amounts to suit you.

We call this ‘tailored drawdown’ – you can find out more about how it works in What is tailored drawdown? Not all providers will offer this option, so do check what your options are and shop around if you need to.

3. Take some income from your ISA instead

Unlike your pension pots, the savings in your ISA generally won’t be taxed at all when you take them. You can pay in up to £20,000 each tax year (across all your ISAs), and you won’t pay tax on the withdrawals, or on any gains you might make.

So, if you’ve got some savings in an ISA, you could think about using them to top up the income from your pension to help keep the tax down. Or you could use your ISA to cover your retirement income entirely before touching your pension. 

For some people, the earlier years of retirement can be a bit more expensive, so the amount of income you need is higher. So it could make sense to use the tax-free withdrawals from your ISA to cover this period.

Then, as you get older and further into retirement, you might find some of your costs start to come down. Maybe you’ve paid off the mortgage, the kinds of hobbies you have are less expensive, or your children don’t rely on you for financial help anymore. All of this could mean you can eventually afford to live off a more modest amount from your pension. And, as you know, the less you take, the less tax you pay.

Want to find out more?

If you want to find out more about the tax you pay on your pension pot, we have a full guide on our website. 

It can also be a good idea to speak to a financial adviser to get advice about your specific circumstances. If you don’t have one already, MoneyHelper has a useful guide to help you choose one to suit you. Or, from age 50, you can get free impartial guidance from Pension Wise, a service from MoneyHelper. Visit their website or call 0800 138 3944.

The information here is based on our understanding in May 2024 and shouldn’t be taken as financial advice.

Pension plans and Stocks & Shares ISAs are investments, so their value can go down as well as up and may be worth less than was paid in.

Your own personal circumstances, including where you live in the UK, will have an impact on the tax you pay. Laws and tax rules may change in the future.

Standard Life accepts no responsibility for information in external websites. These are provided for general information.