Tax treatment depends on your circumstances and is subject to change

Pensions and Tax

Everything you need to know

Pensions are one of the most effective ways to save for retirement in the UK. The money you contribute is boosted through valuable tax relief and employer contributions (if you have a workplace pension). Pensions also benefit from favourable tax treatment compared to other types of investments and savings accounts.

However, the relationship between pensions and tax is complex, with many nuances and rules to be aware of. This detailed guide covers everything you need to know about how different types of pensions are taxed in the UK. It also covers how to make the most of the available tax reliefs and allowances to boost your retirement savings.

How are pensions taxed in the UK?
Whether your pension contributions or withdrawals are taxed depends on several factors:
  • The specific type of pension scheme you have
  • Your current stage in the pension savings journey
  • Your employment status
  • Your tax residency status
  • Your total income from all sources
Below we outline the key points about how the major pension schemes are taxed at different stages.
Personal and workplace defined contribution pensions
Personal pensions and the majority of modern workplace pensions are defined contribution schemes. This means your retirement income depends on how much you and your employer contribute and the investment growth achieved.
Contributions - you receive tax relief on personal and workplace pension contributions up to your annual limits (see below). This means some of tax you pay is effectively refunded back into your pension pot to boost your savings.
Growth - the growth achieved on your invested pension pot is completely tax-free.
Tax-free cash - if you have an eligible scheme, from age 55 you can take up to 25% of your total defined contribution pension pots as a tax-free lump sum. It’s important to remember that taking pension money early is not right for everyone because it will leave you worse off in retirement.
Withdrawals - any pension withdrawals you take over and above your tax-free cash are taxed as income. This means you will pay income tax at your marginal rate on any money taken out of your pension after the 25% tax-free amount. The rates for 2023/24 are:
Basic
rate: 20%
(£12,571 to £50,270)
Higher
rate: 40%
(£50,271 to £125,140)
Additional
rate: 45%
over (£125,140)
Please note that the rates differ if you are living in Scotland
All our opinions regarding taxation and related matters are based on our understanding of the current tax law and practice of HMRC, which is subject to change.
Death before 75 - if you die before age 75 and your pension assets are passed on, your nominated beneficiaries will not have to pay any tax on the death benefits they receive, whether taken as a lump sum or income.
Death after 75 - if you die aged 75 or over, any defined contribution pension assets that are passed on to beneficiaries are subject to income tax at the recipient's marginal rate. This applies whether taken as a lump sum or as income..
In summary, defined benefit pensions enjoy significant tax advantages, with tax relief on contributions and tax-free growth. The key difference between defined benefit and defined contribution pensions is the guaranteed income, which brings long-term security.
In summary, defined contribution pensions, like personal and most modern workplace pensions, receive favourable tax treatment to encourage pension savings. Tax relief goes in, no tax is paid on growth, and just income tax due on withdrawals. Even then, up to 25% can be taken tax-free.
Final salary/defined benefit pensions
Defined benefit pensions are offered by some employers and provide a guaranteed retirement income based on your salary and years of service. They are often referred to as gold-plated pensions.
Contributions - your pension contributions receive tax relief in the same way as defined contribution schemes. Your employer may also contribute on your behalf.
Growth - unlike defined contribution schemes, you do not need to worry about growth. A defined benefit pension promises to pay you a guaranteed income for life from a set age, regardless of how the underlying investments have performed.
Tax-free cash - some defined benefit schemes allow you to take a tax-free cash sum. However, this generally has to be at the point you start receiving your guaranteed income, which will go down in value because of the tax-free lump sum you have taken.
Income - the guaranteed income paid by your defined benefit pension scheme is taxed as regular income under PAYE, but you will not pay National Insurance on it. It is not taxable if it falls below your personal allowance.
Death before 75 - rules for defined benefit schemes are much stricter than with defined contribution schemes. In many cases, when you die a proportion of that guaranteed income will continue to be paid to your spouse or partner, or sometimes a dependent. This income will be taxed as earnings at their marginal rate. In some cases, if the value of the pension is small and if you die while an active member of your defined benefit pension scheme, your beneficiary might be able to withdraw the funds as a tax-free lump sum. Rules vary from scheme to scheme. So, it is important to speak with your pension provider to understand the specific rules that apply to you.
Death after 75 - if you die after 75, income tax is due on death benefits whether they are taken as a lump sum or income.
In summary, the tax treatment of pensions in the UK is designed to provide significant incentives to save for retirement. To understand the taxation of overseas pensions you should consult with your pension provider. If you are looking to transfer your overseas pension it is highly recommended that you seek advice from a regulated financial adviser.
In summary, defined benefit pensions enjoy significant tax advantages, with tax relief on contributions and tax-free growth. The key difference between defined benefit and defined contribution pensions is the guaranteed income, which brings long-term security.
The State Pension
The State Pension is a weekly income provided by the government once you reach State Pension age, and the amount your State Pension is worth is dependent on your National Insurance record. If you reached State Pension age before 6 April 2016, the amount you get will be dependent on the basic State Pension rules. Everyone else falls under the new State Pension rules.
Contributions - you build up entitlement to the State Pension through your National Insurance contributions during working life. These contributions are made with pre-tax income.
Income - the State Pension is taxable income, but most people have an income low enough to fall under the tax-free personal allowance. However, if your total income including the State Pension exceeds certain thresholds, part of your State Pension may become taxable. For example, if you are receiving a workplace pension and State Pension, and the total value of your income exceeds your tax-free personal allowance, you will be taxed at your marginal income rate.
Death - State Pension payments stop when you die, and it only provides an income for the pension recipient. There is no death benefit value to pass on. If you qualify for the Additional State Pension, then your partner may be able to inherit some of this when you die.
Unfunded public sector pensions
Special unfunded public sector pension schemes exist for nurses, teachers, police officers, civil servants, etc. These provide a guaranteed retirement income.
Contributions - you receive tax relief on any employee pension contributions you make to the unfunded public sector scheme.
Growth - as with other pensions, the invested funds grow free of UK income and capital gains tax. However, as with standard defined benefit schemes, the income you receive is guaranteed regardless of the performance of the underlying investments.
Income - the guaranteed income you receive is taxed under PAYE as regular salary income at your marginal income tax rate.
Death before 75 - pension death benefits can typically be paid tax-free to your nominees if you die before age 75. It is important to check with your provider what their particular rules are.
Death after 75 - If you die over age 75, death benefits taken by beneficiaries are taxed as income at their marginal rate.
Overseas pensions
If you have paid into overseas pensions while working abroad, the tax treatment depends on the country and scheme rules.
Contributions - you may be able to claim UK tax relief on contributions to certain qualifying overseas schemes.
Income - income is taxed according to the country you are resident in when taking benefits. Double taxation agreements sometimes apply.
Transfers - moving pensions to/from overseas schemes has complex tax implications. It is important to seek professional regulated advice.
In summary, defined contribution pensions, like personal and most modern workplace pensions, receive favourable tax treatment to encourage pension savings. Tax relief goes in, no tax is paid on growth, and just income tax due on withdrawals. Even then, up to 25% can be taken tax-free.
In summary, the tax treatment of pensions in the UK is designed to provide significant incentives to save for retirement. To understand the taxation of overseas pensions you should consult with your pension provider. If you are looking to transfer your overseas pension it is highly recommended that you seek advice from a regulated financial adviser.
Below we outline the fundamentals of pension taxation to help you to better understand your pension options.
How does pension tax relief work?
One of the key incentives for saving into pensions is that you receive valuable tax relief on your contributions. This means that some of the money you have paid in tax to the government goes back into your pension. This not only helps to increase the value of your pension, it also reduces the amount of tax you pay.
Pension tax relief basics
  • Annual allowance: you can get tax relief on private pension contributions worth up to £60,000 or 100% of your annual earnings, whichever is lower. The amount of tax relief you receive depends on the rate of income tax that you pay. Tax relief is either automatic (known as relief at source) or you have to claim it yourself. Basic rate taxpayers (20% income tax) - receive 20% pension tax relief. For example, if you contribute £100 into your pension, the government adds £20 tax relief. So £120 goes into your pension at a £100 net cost to you. Higher rate taxpayers (40% tax) receive 20% automatic tax relief and can claim an extra 20% relief via self-assessment.
  • Additional rate taxpayers (45% tax) - get 20% basic relief then can claim an extra 25% through self-assessment
  • Please note that the marginal income tax rates differ in Scotland
Your annual income tax allowance
If your annual income, including salary and any pension income, is below £100,000 per year, then your annual income tax personal allowance will not be affected. However, once you start earning £100,000 or more, your personal allowance steadily decreases until you reach £125,140, at which point, you no longer receive tax relief on any of your earnings. So, if you withdraw a large pension lump sum and this takes your total annual income over £100,000, your income tax annual allowance will be affected for that year.
Carry forward
If you have not used up your full annual pension allowance in the last 3 tax years, you can carry forward this unused allowance to add to your available allowance in the current tax year. This means you may be able to receive tax relief on more than £60,000 of contributions in a tax year.
Money Purchase Annual Allowance
Once you withdraw from your defined contribution pension funds exceeding your 25% tax-free lump sum, the Money Purchase Annual Allowance kicks in. This reduces the amount you can contribute to your pension each year and still receive tax relief to £10,000.
8 common pension and tax questions answered
Pensions and tax is a complex subject, and many people have questions about how contributions and withdrawals are taxed. Below we provide detailed answers to some of the most frequently asked questions:

4 tax tips to boost your pension savings
There are various ways to manage your pensions tax-efficiently and make the most of your allowances.
1. Maximise tax relief - contribute as much as you can reasonably afford to each year because you will benefit from tax relief, which is essentially free money.
2. Use carry forward rules - if applicable to you, make extra pension contributions by using any unused annual allowance from the previous 3 tax years.
3. Track your MPAA - once accessing your pension, your annual allowance is just £10,000 so monitor contributions.
4. Take tax-free cash in stages - consider taking your 25% pension commencement lump sum in instalments over multiple tax years. Speaking with a regulated financial adviser can help to guide you through the best options for you.
In summary
Making the most of your pension allowances and thresholds now means more funds to provide for your future. A regulated financial adviser can review your particular situation and suggest appropriate tax-planning steps to implement.

In summary, while the tax system provides incentives to save into pensions, tax is still due in retirement on most withdrawals and income. Seeking regulated financial advice can ensure you are aware of all of the options available to you for your particular pension schemes.
The details provided in this article are for general information only and are in no way deemed to be financial advice. All of the material is correct as of the publication date, but could be out-of-date by the time you read the article.
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