Paying Tax in Retirement
Learn how paying tax in retirement works, from pension withdrawals to state pension and investment income. Discover allowances, tax bands, and practical tips to reduce your retirement tax bill.
Planning for retirement isn’t just about saving and investing - it’s also about understanding how your income will be taxed. Knowing what to expect can help you manage your money effectively and avoid unexpected bills. This guide breaks down the basics of paying tax in retirement, including common income sources and important considerations.
Do You Pay Tax on Pension Income?
Yes, pension income is considered taxable. This means that once you start drawing income from your pension, it may be subject to income tax in the same way as your earnings during working life. However, not all of it is taxed:
Tax-Free Lump Sum: You can usually take up to 25% of your pension pot as a tax-free lump sum when you begin accessing your pension.
Remaining Income: Anything you draw from your pension beyond that 25% is taxed as income.
What Counts as Taxable Income in Retirement?
In retirement, your taxable income can include:
State Pension: Although taxable, it’s paid without tax deducted. If you have other income, you may need to pay tax through PAYE or a tax return.
Private or Workplace Pensions: Income from defined benefit (final salary) or defined contribution pensions is taxable.
Earnings: If you work part-time or freelance in retirement, your income is taxable.
Savings and Investments: Interest or dividends may be taxed if they exceed your tax-free allowances.
Rental Income: Profits after allowable expenses on rental properties are also taxable.
These sources of income can add up, so it's important to understand how they may affect your total income and whether you'll need to pay tax during retirement.
How Does Income Tax Work in Retirement?
Income tax in retirement follows the same rules as during working life. For the 2025/26 tax year:
Personal Allowance: First £12,570 of income is tax-free.
Basic Rate (20%): Income from £12,571 to £50,270.
Higher Rate (40%): Income from £50,271 to £125,140.
Additional Rate (45%): Income above £125,140.
If your income exceeds £100,000, your tax-free Personal Allowance starts to go down. For every £2 you earn above £100,000, you lose £1 of your Personal Allowance. This means that by the time your income reaches £125,140, your Personal Allowance is reduced to zero, and all of your income becomes taxable.
Managing Tax on Your Pension
Here are some ways to reduce how much tax you pay on pension withdrawals:
Use Your Tax-Free Lump Sum: This can reduce how much of your pension income is taxable. You can take this either as a one off lump sum or as a series of lump sums – this includes even taking it on a monthly basis.
Withdraw Strategically: Only take what you need to avoid moving into a higher tax band.
Split Income Across Tax Years: Spreading withdrawals across different years may reduce your tax liability.
Tax on the State Pension (State Pension Tax Rules)
The State Pension is taxable but is paid gross, meaning no tax is automatically deducted. If your only source of income is the State Pension and it is below the Personal Allowance (currently £12,570), you won't need to pay tax. However, if you have other sources of income such as a workplace or private pension, rental income, or part-time earnings, your combined income might exceed your tax-free Personal Allowance. In this case, you could owe tax and may need to pay it through PAYE or complete a Self-Assessment tax return to settle the balance.
PAYE: If you receive other pensions, tax may be deducted through your pension provider.
Self-Assessment: If needed, you must report your income and pay tax yourself.
Tax on Savings and Investments in Retirement
Even in retirement, some savings and investments are taxable:
ISAs: Income and gains remain tax-free.
Savings Interest: Covered by the Personal Savings Allowance - £1,000 for basic-rate taxpayers, £500 for higher-rate, and £0 for additional-rate taxpayers.
Dividends: The annual tax-free allowance is £1,000 (reducing to £500 from April 2025), and dividend income above that is taxed at your standard dividend tax rate.
What About Inheritance Tax (IHT)?
While you don’t pay IHT on your pension during your lifetime, it may apply when passing on your pension or other wealth:
Before Age 75: Defined contribution pensions can usually be passed on tax-free.
After Age 75: Your beneficiaries will pay income tax on withdrawals at their own rate.
This makes pensions a potentially useful tool for passing on wealth, as they are treated differently from other parts of your estate for inheritance tax purposes. It's important to keep your pension beneficiaries up to date and understand the tax implications so your loved ones receive the maximum benefit.
However please note that the way pension pots are treated for inheritance tax purposes is currently under review and there are proposed changes that are planned to come into force after 6th April 2027. These proposed changes include that any unspent pension pots will form part of an individuals estate on death and might be subject to inheritance tax.
Final Thoughts
Understanding how tax works in retirement helps you avoid surprises and plan better for your financial future. Taking advantage of allowances, planning your withdrawals, and keeping track of your income can all help reduce your tax bill.
For more guidance on tax-efficient retirement strategies, read our related articles:
Risk Warnings:
The tax treatment is dependent on individual circumstances and may be subject to change in future. Tax planning advice is not regulated by the Financial Conduct Authority.
A pension is a long term investment. The fund value may fluctuate and can go down. Your eventual income may depend upon the size of the fund at retirement, future interest rates and tax legislation.
Inheritance tax planning is not regulated by the Financial Conduct Authority.
Approved by InPartnership FRN 192638 June 2025