How Is My Pension Taxed?

The Pensions Advisory Service

Normally, any pension paid to you is treated as earned income and may be liable to income tax.

Pensions and income tax

Pension income paid to you is normally treated as earned income for income tax purposes, although you don’t pay any National Insurance contributions on your pension income. But bear in mind that you will normally be able to take some of your pension benefits (typically up to 25% of the value of your pension) as a tax free lump sum at outset.

How much will you pay?

The amount of income tax that you may pay depends on your gross taxable income (the total amount of income potentially liable to tax that you receive). You do not pay any income tax if your gross income does not exceed any personal allowance you may have (the standard personal allowance for the tax year 2020/21 is £12,500). HM Revenue & Customs (HMRC) should tell you how much your personal allowance is each time it changes.

If your gross income is more than your personal allowance, you are liable to pay income tax on the amount that exceeds the personal allowance. Different rates of income tax apply depending on the type of income and how much it is. If you’re receiving pension income, your pension provider will normally calculate how much tax you are liable for, using your tax code, and deduct this tax before paying the balance across to you.

If you receive your pension income, including any State Pension you receive, from more than one source, each provider is given a tax code for the income they pay you. This allows them to calculate how much tax they should deduct and pay to HMRC on your behalf.

Things you should check

You should check each year that the correct amount of income tax has been deducted from the pension payments you receive, especially if you have other sources of income, such as a part-time or full-time job, bank or building society interest and/ or dividends or distributions from investments.

If you have had more tax deducted than you should have paid, you can reclaim the difference from HMRC. Similarly, you may also have to pay any tax that has been underpaid. If you need to reclaim tax when you’ve stopped working you can fill in claim form P50 and send this to HMRC. Alternatively, if you fill in a Self Assessment tax return you can make the reclaim via this return.

If you’re a member of a defined contribution pension scheme and you’re looking to draw retirement benefits, you may have full flexibility on the amount that you can receive. This may include up to the total amount of your pension pot.

However, you should be aware that if you take substantial amounts from your pension pot you could become liable to pay higher rates of income tax (potentially up to 45% of the amount withdrawn, 46% in Scotland) so you may receive substantially less than the value of your pension pot.

What tax is payable on pensions when someone dies?

If you inherit an income drawdown fund on the death of an individual who was under aged 75 when they died, any income you take from the fund will be tax-free and if you decide to buy an annuity with the remaining fund from an insurance company, the annuity paid to you will be tax-free.

If you receive an annuity on the death of an individual who was under aged 75 when they died, the annuity paid to you will be tax-free.

If an individual dies at age 75 or over any remaining pension can be taken by beneficiaries as an income or lump sum at their marginal rate of income tax.

If you receive a dependants’ pension paid from a defined benefit scheme this will be taxed at your marginal rate, regardless of the age of the individual when they died.

Quick facts

  • Income that you draw from your pension scheme is taxed as earned income but is not subject to National Insurance contributions
  • The tax due may be deducted at source by your pension provider and paid to HMRC on your behalf
  • Members of defined contribution pension schemes have full flexibility on how they can draw down their pension pot.