Pension Drawdown Tax: All You Need to Know

Whether you’re planning for your retirement or already enjoying its benefits, it’s important to keep in mind tax implications that will affect your pension income. The exact amount you’ll need to pay will depend on how you choose to withdraw your pension, and how much you are withdrawing. 

In this article we explore pension drawdown tax in more detail. 

What is Pension Drawdown Tax?

Pension drawdown tax is the tax you’ll encounter when you start withdrawing money from your pension after retiring.

When you retire and decide to access your pension savings, you can choose how you want to take that money out. Whether you opt for an annuity or drawdown, or a combination of both,  you are entitled to take up to 25% tax-free and the rest is taxed at marginal rates, the same way income tax is. 

It’s calculated based on your total income for the year, including any other earnings you might have. Therefore it’s advisable to consult with pension advisors or tax professionals who can provide personalised guidance on the most tax efficient way to withdraw your pension. 

How Much Drawdown Tax Will You Have to Pay? 

The amount that you’ll have to pay will depend on the income tax band that you fall into for that year. This will take into account the amount you withdraw from your pension pot as well as any other sources of income that you have. 

Other income sources might include: 

  • Your state pension
  • Any other pension income (for example if you also have an annuity)
  • Rental income from properties that you own 
  • Any employment income you might still be receiving 

The HMRC income tax bands (2024-25) are*: 

BandTaxable incomeTax rate
Personal AllowanceUp to £12,5700%
Basic rate£12,571 to £50,27020%
Higher rate£50,271 to £125,14040%
Additional rateover £125,14045%

*These rates are different if you live in Scotland

Example

Let’s take a look at an example scenario if the lump sum is taken all in one go: 

If you have a pot of £100,000 and take all of your 25% tax-free lump sum, you’ll be left with £75,000 which can move into drawdown and take regular withdrawals from when required. If you take an annual income of £3,000 from your drawdown pot and are a basic rate taxpayer (your total income is up to £50,270), you’ll be taxed 20% on this withdrawal and get £2,400. 

There will likely be other income to factor in since most pensioners have some other form of income. So to find out exactly how much tax you will be subject to and how to suitably manage the amount you pay, speak to a pension advisor. 

It’s worth noting that you aren’t obligated to take the entire 25% lump sum, despite common assumptions. In many cases, such as with phased drawdown, individuals might be better off not taking the full amount in one go.

What are the Pension Drawdown Tax Rules?

Here are the rules for pension drawdown tax, at a glance:

  • You can withdraw up to 25% of your pension pot as a tax-free lump sum. However, this is not always advisable – most people don’t need the 25%. Consider leaving this invested with the ability to get more tax free cash. If you have an IHT liability then take the full 25%, this lump sum would be taxed at 40% after death.
  • Anything withdrawn from the remaining 75% will be taxed.
  • You will only pay income tax if your annual income is above £12,570, where your drawdown will be subject to income tax.
  • If you are still contributing to your pension while withdrawing, there is a maximum amount you can contribute to your pension in a tax year while still receiving tax relief. If you exceed this allowance, you may incur tax charges.
  • If you withdraw from a Defined Contribution (DC) pension pot, the amount you can contribute while receiving tax relief will be reduced – this is known as Money Purchase Annual Allowance.

MPAA Rules

Money Purchase Annual Allowance (MPAA) only applies to DC pensions – Defined Benefit pensions will not trigger MPAA. 

Here is how the MPAA may be triggered:

  • Taking an Uncrystallised Fund Pension Lump Sum (UFPLS): Each withdrawal typically has 25% that is tax-free, with the rest being taxable. Accessing your pension this way triggers the MPAA.
  • Flexi-Access Drawdown: When you convert your pension pot into drawdown after 6 April 2015 and start taking income (beyond the tax-free cash), it triggers the MPAA.
  • Buying a Flexible Annuity: If the annuity allows varying levels of income over time, it could trigger the MPAA.

What Does Not Trigger the MPAA?

  • Taking a tax-free lump sum only: If you only take the 25% tax-free lump sum and do not touch the rest of your pension, the MPAA is not triggered.
  • Buying a Lifetime Annuity: Purchasing a lifetime annuity that provides a consistent, regular income does not trigger the MPAA.
  • Capped Drawdown: If you were in capped drawdown before 6 April 2015 and you haven’t exceeded the cap, the MPAA isn’t triggered.
  • Small Pot Lump Sums: Taking small pot lump sums of up to £10,000 each from separate pots (and up to three pots from personal pensions) doesn’t trigger the MPAA.

Tax implications for different pension options

The two main ways to access your personal pension in the UK are annuity and drawdown. These are both taxed according to marginal rates, though the amount you’ll pay might be different. That’s because with drawdown it will depend on when and how much you withdraw.

With each option you are entitled to take up to 25% of your pension pot tax-free.  

Let’s take a look at some of the different options in more detail below: 

  • Partial drawdown

Partial drawdown allows you to withdraw a portion of your remaining pension fund while leaving the rest invested. This option is suitable for individuals who want to maintain control over their pension savings and have the flexibility to access funds as required.

Each withdrawal is typically subject to income tax on the taxable portion, similar to the initial lump sum withdrawal. The amount you pay will depend on how much you withdraw.

  • Phased income drawdown

With phased income drawdown, you can set up a schedule for regular withdrawals, such as monthly or annually, to provide a steady income stream in retirement.

Like partial drawdown, each withdrawal is typically subject to income tax on the taxable portion.

  • Annuity 

An annuity is a financial product that provides a guaranteed income for life or for a set period in exchange for a lump sum payment from your pension fund. Annuities offer security and predictability, as you know exactly how much income you’ll receive, regardless of market fluctuations or how long you live. 

Since you’ll be getting a set amount each month, you can think of annuity tax in the same way as income tax. You get an income tax threshold (your personal allowance up to £12,570) and everything over that you’ll pay income tax on. 

As with drawdown, your total income will be taken into account for your tax rate, not just the income from your annuity. 

  • UFPLS (Uncrystallised Funds Pension Lump Sum)

UFPLS is a method of accessing your pension pot where you can take one or more lump sums from your pension fund, with 25% of each withdrawal being tax-free. The remaining 75% is subject to income tax at your marginal rate.

  • Tax-Free Cash

Tax-Free Cash, also known as the Pension Commencement Lump Sum (PCLS), is a portion of your pension pot that you can withdraw tax-free when you start taking your pension benefits. In most cases, you can take up to 25% of your pension pot as a tax-free lump sum.

  • Blending Income

Blending income involves combining different sources of retirement income to optimise tax efficiency and meet your financial needs. This could include income from various pension schemes, annuities, investments, and other sources. Blending income can help minimise tax liabilities and provide a sustainable income stream throughout retirement.

Drawdown Tax FAQs

Is Drawdown Tax Applicable to Multiple Pension Pots?

Yes, each pension pot is subject to its own drawdown tax. This tax cannot be transferred between pots. When you withdraw from any pension pot, it is treated as its own withdrawal, and thus is subject to being taxed.

Does National Insurance Need to be Paid on Pension Drawdown?

No, payments from your pension plan are not subject to national insurance tax.However, if you are withdrawing more than the tax-free amount, you may be subject to income tax.

How Much Can I Withdraw Through Drawdown?

There is no limit on the amount you can withdraw from your pension through drawdown. But it might be within your interests to spread out withdrawals to make them more tax efficient. This is where a pension advisor will be able to help you make the right decision. 

At What Age Can I Withdraw Money from my Pension?

You can currently access your pension pot from 55, and while you are still working. However, the minimum age for withdrawing pension is going up, so this is something to keep in mind.

Can I Drawdown My Full Pension Amount?

Yes, technically you can withdraw your whole pension as your lump sum. However, this is likely not the best option for tax reasons. 

What Are The Implications of Triggering MPAA?

When the MPAA is triggered, the amount you can contribute to your money purchase pensions annually and receive tax relief on reduces significantly. Initially set at £10,000 when introduced, the MPAA was reduced to £4,000 per annum as of April 2017.

There’s a few drawbacks to triggering the MPAA, including:

  • Reduced contribution allowance: as soon as MPAA is triggered, the amount you can contribute to your pension annually is reduced. This limits your ability to save for retirement through pensions.
  • Loss of tax efficiency: Contributions to pensions benefit from tax relief, meaning you receive tax relief on contributions up to certain limits. However, triggering the MPAA significantly reduces this tax-efficient saving opportunity. With the reduced allowance, you’re limited in your ability to benefit from tax relief on pension contributions.
  • Employer contributions: Triggering the MPAA can also affect employer pension contributions. If your employer matches your contributions up to a certain level, the reduced allowance may mean you miss out on some of these matching contributions, reducing the overall value of your pension savings.

Disclaimer: Inheritance Tax/Estate Planning is not regulated by the Financial Conduct Authority. Tax treatment varies according to individual circumstances and is subject to change.