Tax on your pension: how to keep more of your retirement savings

As you approach the end of your working life, it is time to reap the rewards of your financial plan. You can begin drawing from your retirement savings to fund your dream lifestyle whether that involves travelling, finding new hobbies, or spending time with family.

However, if you lose a significant amount of your retirement income to tax, you may find it more difficult to fund the retirement you imagined. 

Unfortunately, stubborn inflation and frozen Income Tax thresholds could mean that you may be more likely to lose a portion of your pension income to tax in the future. 

According to This is Money, 8.5 million over-65s will pay Income Tax this year, up from 6.8 million in the 2020/2021 tax year.

Fortunately, if you consider the way that you draw from your savings, you may be able to reduce the tax that you pay and keep more of your wealth.

Read on to learn some of the most effective ways to potentially reduce tax on your pension income.

1. Avoid drawing from your pension for as long as possible

You can typically access your pension when you reach the Minimum Pension Age of 55 (or 57 from 2028 onwards). Yet, you do not have to start drawing the money at this point and it may be beneficial to avoid taking money from your pension for as long as possible – especially if you still have earnings.

As soon as you draw flexibly from a defined contribution (DC) pension, you will likely trigger the Money Purchase Annual Allowance (MPAA). This effectively reduces the amount that you can contribute to your pension from your earnings before additional tax charges are due from £60,000 to £10,000 (2023/24).

Fortunately, if you defer drawing from your pension, you can avoid this and continue building tax-efficient savings for longer. 

Additionally, funds that you draw from your pension are taxed as income while other wealth, such as savings in a Cash ISA, are not. Consequently, if you rely on these funds for as long as possible instead of drawing from your pension, you may be able to reduce the tax that you pay.

Savings in your pension also remain invested until you draw them, so you may benefit from more growth if you leave your pension for as long as possible.

2. Take advantage of pension drawdown

When you want to generate an income from your pension, you typically have two options – purchasing an annuity or transferring your pension into drawdown.

An annuity provides a fixed income for an agreed period, in exchange for a portion of your pension savings. The guaranteed income from an annuity may be attractive during a period of uncertainty, but it can make it more difficult to mitigate the Income Tax you pay.

You cannot usually change the level of income that you receive from an annuity. However, if you transfer your pension into drawdown, you retain more flexibility.

This may benefit you because you can draw a lower income in certain years and supplement it with your other savings. As a result, you may be able to avoid exceeding your Personal Allowance or moving into a higher tax bracket, so you pay less Income Tax.

While annuities may be a suitable option for you, it could be worth considering the potential benefits of drawdown and how it may help you reduce tax on your pension.

3. Spread out your tax-free lump sum

You can usually take 25% of your pension as a tax-free lump sum and, typically, your provider allows you to take it in one go or split it into smaller withdrawals.

In some cases, you may decide to take the full 25% in one lump sum. However, you may be able to reduce the Income Tax you pay if you spread it across multiple tax years.

If you can stay within the 25% tax-free entitlement and avoid drawing the remaining 75% for as long as possible, you may not pay as much Income Tax. 

As such, it may be worth taking smaller amounts instead of withdrawing the full 25% if you are not going to spend it right away.

4. Forecast your spending in retirement

To reduce the tax that you pay, you may need to limit your pension withdrawals and only take what you need to fund your lifestyle.

As such, it is important to accurately forecast your spending in retirement. That way, when you come to withdraw money from your pension, you can avoid inadvertently taking more than you need.

Working with a financial planner can be beneficial here. They can use cashflow planning to help you determine what level of income you are likely to need to fund your lifestyle. More importantly, these forecasts can account for factors such as inflation, which will likely affect how much you need to draw from your pension.

Ultimately, this will make it easier to draw the right amount from your pension so you can potentially limit the Income Tax you pay without making sacrifices to your lifestyle.

5. Consider estate planning and Inheritance Tax

Reducing the Income Tax you pay on your pension means you can retain more of your wealth during retirement. But you may also want to consider the tax implications when passing your pension on to loved ones after you die.

Pensions can be a useful estate planning tool as they normally fall outside of your estate. This means that your family normally don’t pay Inheritance Tax (IHT) when they inherit your pension.

However, depending on how old you are when you die, they may need to pay Income Tax when they come to withdraw the funds. Usually, they can take a lump sum or a regular income from an inherited DC pension without paying Income Tax, provided you die before you are 75.

Yet, if you are older than 75 when you die, they will likely pay Income Tax on any withdrawals. 

Discussing your estate plan with a financial planner can help you determine the most tax-efficient way to pass wealth to your loved ones.

Get in touch

If you are concerned about the tax you are likely to pay on your pension, we can help you find ways to retain more of your wealth.

Please contact us at or call 01904 655 330. As an award-winning financial advice company that was a 2022 VouchedFor Top Rated firm, you can be sure that we’re a bona fide company providing excellent advice and high-quality service.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results. 

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.

The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.

The Financial Conduct Authority does not regulate cashflow planning.

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By talking about your current situation and listening to your aims, we create a personalised plan that will put you on a path to achieving your aspirations.

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