Taking your pension savings? Keep these tax tips in mind

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Paying tax is part and parcel of taking your pension savings – but how much tax you pay can sometimes depend on how you choose to take them. We look at why some people have found themselves facing a high tax bill and give you some top tips for being tax efficient.

How are you taxed on your pension savings?

Let’s kick things off with a recap of how people are taxed on their pension savings. When you take money from a pension plan, you can normally take 25% tax free. For example, if you have a plan worth £20,000, you could take £5,000 without being taxed on it. £268,275 is usually the maximum you can take tax free across all your pension plans, unless you have particular protections in place. 

The remaining 75% is usually taxable when you take it. And it’s taxed depending on which tax band you fall into. You can find out more about tax bands on the government’s website. Tax bands and rates are different depending on where you live in the UK.

Most people have a ‘personal allowance’, which is the amount of income they can get in a year that they don’t have to pay tax on. The personal allowance in the current tax year is £12,570. So you’d usually only pay tax on anything you receive above this amount.

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How you take your pension savings can make a big difference

We recently looked at some data from the Financial Conduct Authority (FCA). And we found that, recently, people have paid thousands or even tens of thousands of pounds in tax after taking all the money from their pension plan in one go.

Between October 2022 and March 2023, 221 people in the UK took a pension plan worth more than £250,000 in one go – and that was the pot size after taking 25% tax free. The result? They would’ve faced a tax bill of at least £97,500.*

During that same time, more than 1,500 people cashed in pension plans worth between £100,000-£249,000, having already taken 25% tax free. These people would’ve paid a minimum of around £27,400 in tax.

Even taking a smaller amount in one go can result in a tax bill that’s over £1,000. For example, someone cashing in a pot worth £19,500 (again, after taking money tax free) could expect a tax bill of around £1,400. 

We’re assuming these people’s only income is their pension plan. But their tax bill could be even bigger if they’re getting money from other sources too.

How can you be more tax-efficient when taking your pension savings?

1) Consider taking your pension savings in smaller chunks

In some cases, it might make sense for someone to take their money in one go (particularly if it’s a pension plan worth under £10,000 – read our recent article on small pots for more details). But as you’ve just seen, when you take a large sum from your plan at one time, you’re likely to be hit with a hefty tax bill.

There are other options you could consider. For example, you may be able to opt for drawdown. Drawdown lets you take regular amounts from your plan or take money as and when you want it. 

You could also consider an annuity. This option can also give you smaller, regular amounts over the years, and it’s designed to give you a guaranteed income for the rest of your life. 

Some people even choose a combination of options. For example, someone might convert part of their plan into an annuity, then take what’s left via drawdown. 

It’s important to think carefully about what’s right for your circumstances.

2) Consider taking your tax-free money gradually

If your pension plan allows for it, you might have the option of taking your 25% tax-free entitlement in smaller chunks over time, rather than all at once.

This way, you could take some money from the taxable part of your pension plan as well as some of your tax-free money. Doing this can help you lower your tax bill. In some cases, it can even mean you don’t pay tax at all (assuming the money you’re taking from the taxable part isn’t putting you over your personal allowance). 

3) Consider taking money from an ISA

Got money in an Individual Savings Account (ISA)? If so, you could think about taking some of this before you dip into your pension savings. Or you could use it to supplement what you’re taking from your plan. 

Normally, you can pay in up to £20,000 across your ISAs in a tax year, and then you usually won’t need to pay tax on your gains or what you withdraw. So using an ISA (or other savings) to supplement your pension income could be a way to keep your tax bill lower – but it’s important to think about your own individual circumstances and whether it’s right for you and your plans.

Where can you get more support?

If you’re unsure about what’s right for your individual circumstances, consider getting financial advice from a financial adviser. You can find out more about getting financial advice on MoneyHelper.

If you’re over 50, you can get free impartial guidance from Pension Wise, a service from MoneyHelper. Visit their website or call 0800 138 3944.

*Calculated using Which’s tax calculator income tax calculator and salary calculator for 2022-23 - Which? Figures rounded to nearest £100.

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

Pension plans and some types of 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.