Tax in retirement

From age 55, you can access your pension pot. What you do with it is up to you. You may use some to buy an annuity for a reliable lifetime income, or you can choose to draw down an income from your pension while it remains invested.

Income Tax

If you choose to take a lump sum or drawdown from your pension pot, typically 25% of each withdrawal will be tax-free and the rest will be taxed as income.

If your annual income is less than £100,000, you are usually entitled to £11,000 tax-free personal allowance. You only pay Income Tax if your taxable income, including pension income, is more than your personal allowance.

Taxable income withdrawals attract tax at incrementally high levels depending on whether or not the size of the withdrawal triggers basic-, higher- and additional-rate tax levies.

National Insurance and Income Tax

When you reach the State Pension age, you normally don’t have to pay National Insurance contributions, once you have paid off any contributions that were due before you reached that age.

If you are still working, you will need to prove your age to your employer in order to stop the contributions from being deducted from your pay. To do this you can usually show them a birth certificate or passport, or you can fill in a certificate of age exemption – this should be sent automatically if you say you’re working when you claim your state pension. If you're self-employed, just tick the relevant box on your self-assessment tax return to stop your National Insurance contributions from being taken.

How income tax is collected from your pension income

State Pension

Your state pension income is paid gross. However, this does not mean that it is tax-free. If your total income, including your state pension is greater than your personal allowance, tax will be due on your state pension income.

If you have a private pension or earnings this is collected via PAYE deductions. The amount of state pension is deducted from the tax-free personal allowance available to your main employment or pension, leaving less tax-free income available from this income source.

Private pensions

Income received from your private pensions – these include annuities, employer pension schemes, drawdown income and taxable lump sum withdrawals – will have tax deducted at source via PAYE.

Tax codes

HMRC's PAYE System enables them to bring together information from employers, pension providers and the Department for Work and Pensions (DWP). Your tax office will assign appropriate tax codes to your various pension income sources.

The code is used by the pension provider to deduct the correct amount of tax from your income payment via PAYE.
It is important to check the codes that are assigned to your income sources. It is not uncommon for these to be incorrect, especially when you first enter into retirement.

Married Couple's Allowance

If you are married or in a civil partnership and one of you was born before 6 April 1935, you may be entitled to married couple's allowance.

Married couple's allowance is normally issued to the the husband. However, if you married or became civil partners on or after 5 December 2005, it is given to the partner with the higher income.

The married couple’s allowance is different from other personal allowances as it is a deduction in your tax bill. It won't increase the amount of income you can receive before you pay tax. Instead, it reduces your tax bill by 10% of the allowance you're entitled to.

For the 2016/17 tax year the minimum amount of married couple's allowance is £3,220, and the maximum is £8,355.

Reducing your tax bill

There are a number of legitimate ways you can reduce the amount of tax that you need to pay in retirement. These include:

  • Maximise the use of tax efficient savings such as ISAs.
  • Plan as a couple. If one of you is a non-taxpayer or pays tax at a lower rate, consider transferring income-producing assets to them
  • Make donations to charity under Gift Aid. This reduces your ‘adjusted net income’ which is used to calculate your personal allowance.
  • Think about the types of investments that you hold. If you hold shares or funds that generate a significant amount of dividend income each year, it may be advantageous to review your investment strategy and invest investments that are designed to produce capital growth. This could reduce the amount of taxable dividend income you receive.

Next steps

Tax can be complicated, and it’s important to make sure that you’re paying neither too much nor too little. For detailed tax planning advice tailored to your circumstances, speak to a financial adviser.

The Financial Conduct Authority does not regulate taxation and trust advice

Last updated: 05 April 2016