Pension pots and income tax - some examples

Before you take money from your pension pot, you need to consider some of the factors that affect the amount of tax that may need to be paid. We’ve put together some fictional examples to help with this.

Giving some thought to the timing of your withdrawal could make a big difference to your income tax bill.

Two examples…

The examples below show how much income tax two fictional characters might pay on money taken from their pension pots – not their total tax liability.

Usually 25% of the pension pot can be taken tax free. In both our examples, this would be £12,500.

John’s pension fund

John has recently retired and has a pension pot worth £50,000.

He’s not old enough to receive State Pension, so he’s relying on his pension pot to help provide a living until he becomes eligible for this. John has no other sources of income.

How John chooses to take money from his pension pot will affect the amount of tax he has to pay.

He takes all his money from his pension in one year

  • £5,300The tax mans share
  • £44,700John's share

He takes £12,500 from his personal pension in each of the 4 years

  • £50,000 tax freeJohn's share

We have assumed that John has the correct PAYE code and has not taken any other income within the same tax year. In reality taking a lump sum may trigger emergency tax so any overpayment of tax would have to be reclaimed.

Nasreen’s pension fund

Nasreen is approaching her planned retirement age.

She has £50,000 in her pension pot and currently earns a salary of £20,000 a year. She wants to take some money from her pension pot before she retires.

How Nasreen chooses to take money from her pension pot will affect how much income tax she has to pay.

She takes all her money from her pension in one year

  • £10,400The tax mans share
  • £39,600Nasreen's
    share

She takes £12,500 from her personal pension in each of the 4 years

  • £7,500The tax mans share
  • £42,500Nasreen's
    share

We have assumed that Nasreen has the correct PAYE code. In reality taking a lump sum may trigger emergency tax so any overpayment of tax would have to be reclaimed.

How did we work out the figures in John’s and Nasreen’s examples?

  • The tables below show how the withdrawals in each of the examples above would be taxed.
  • The figures shown are for example only. The amount of tax you might need to pay when taking money from your pension fund would depend on your personal circumstances

John's pension fund

In year 1 (John)

Tax Band Tax Rate Amount of Pension in Tax band Tax payable
£0 - £11,000 0% £11,000 £0
£11,001 - £43,000 20% £26,500 £5,300
£43,001+ 40% £0 £0
Yearly Amount   £37,500 £5,300
Tax-free-cash   £12,500 £0
Total Tax Payable     £5,300

Over Four Years (John)

Tax Band Tax Rate Amount of Pension in Tax band Tax payable
£0 - £11,000 0% £9,375 £0
£11,001 - £43,000 20% £0 £0
£43,001+ 40% £0 £0
Yearly Amount   £9,375 £0
Tax-free-cash   £3,125 £0
Total Tax Payable     £0

Nasreen’s pension fund

In Year One (Nasreen)

Tax Band Tax Rate Amount of Pension in Tax band Tax payable
£0 - £11,000 0% £0 £0
£11,001 - £43,000 20% £23,000 £4,600
£43,001+ 40% £14,500 £5,800
Yearly Amount   £37,500 £10,400
Tax-free-cash   £12,500 £0
Total Tax Payable     £10,400

Over Four Years (Nasreen)

Tax Band Tax Rate Amount of Pension in Tax band Tax payable
£0 - £11,000 0% £0 £0
£11,001 - £43,000 20% £9,375 £1,875
£43,001+ 40% £0 £0
Yearly Amount   £9,375 £1,875
Tax-free-cash   £3,125 £0
Total Tax Payable     £7,500

The table assumes that:

  • John and Nasreen have no income, other than that stated above, within the tax years relevant to the examples above.
  • No State Pension is being paid to either of the people in the examples.
  • The money taken over four years is evenly split between four tax years.
  • Tax rates and bands remain the same (i.e. 2016/2017).
  • There’s no change in the value of the investments. We’ve assumed this for the sake of simplicity.
  • Examples show tax liability for the whole tax year. In reality pension withdrawals would most likely be taxed on a month one basis meaning emergency tax may be applied. We have assumed that John and Nasreen have the correct PAYE codes. If that wasn't the case it may result in more tax being deducted which would have to be reclaimed.

Pension pots and tax - a reminder:

While money remains in a pension fund, any growth in the value of investments within it will be largely free of tax on income and capital gains - so take time to consider if and when a pension withdrawal is the best option for you. But please bear in mind that the value of the fund could go down as well as up and you may get back less than has been invested.

The only tax suffered in the fund could be when any investment returns are received with tax credits or after tax deductions which cannot be reclaimed.

Things to consider

  • This is a simplified example - the figures shown are just for guidance. Any other income John or Nasreen received in the tax years in which they took withdrawals could alter the figures shown. It's also possible, depending on the situation, that tax might initially be deducted at a higher rate, in which case they would have to reclaim any overpayments.
  • The four year time period is shown purely to illustrate the effect of taking withdrawals over a number of tax years - it has no significance beyond this.
  • Taking your pension when your income is lower will often reduce your tax bill. Remember, your income includes things such as any money you receive in interest above your personal savings allowance or from investments - not just your earnings from work or State Pension.
  • Spreading out withdrawals from your pension could mean less of your money is eligible for higher income tax rates. meaning you pay less tax.
  • You need to think carefully about when within the tax year you take out your money. If for instance, you withdraw money in March, earnings all the way back to the previous 06 April will count towards your tax allowance.
  • The information on this page is based on our current understanding of tax rules, these rules may change.

Pension Wise has been set up by the government and offers free and impartial guidance for people retiring with defined contribution pensions. It will help you understand what your choices are and how they work.

You'll be able to get help on the Pension Wise website, over the phone or face to face.

If you are approaching retirement we recommend you get guidance or advice to help you understand your options.

Tax help for older people

A video from the charity Tax Help for Older People can help you understand the tax on your pension withdrawals.

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