How To Minimise Taxes On Pension Withdrawals

Not surprisingly, many of our clients want to know how to minimise tax on their pension income. After all, keeping your tax burden as low as possible will go a long way towards helping your pension funds stretch that bit further. Hilltop’s pension advisers can provide strategies to help you minimise the tax you pay when withdrawing money from your pension.

In this article, we’ll provide valuable insights on how to minimise tax on pension withdrawals and how our years of experience and expertise can benefit you.

Will I Be Required To Pay Tax On My Pension Income?

Saving in a pension is one of the most tax-efficient ways of saving for your future, but when the time comes to withdraw your funds, you will need to pay income tax on your pension. Up to 25% of a defined contribution pension can be withdrawn tax-free, either in one go or in stages – this is known as pension drawdown. 

The income tax you pay on your pension then depends on the amount of money you withdraw over and above the tax-free threshold and any other taxable income. 

The first £12,570 of your income in any tax year is tax-free – this is known as the ‘personal allowance’. If your income exceeds £12,570, you will start paying tax at the ‘basic rate’ of 20%. Once your income reaches £50,270, you will pay tax at the ‘higher rate’ of 40%, rising to the ‘additional rate’ of 45% for income over £125,140. 

So as you can see, any withdrawals you make from your pension could tip your taxable income into a higher tax bracket. 

How Does Tax Impact My Retirement Income?

The amount of money you withdraw from your pension, over and above the tax-free threshold, will determine which of the tax bands you fall into that tax year, which will then influence how much income tax you pay HMRC. So it’s certainly in your best interests to think carefully about the withdrawal method and amount to ensure that taxes don’t erode the value of your pension too much.

How Can I Avoid Paying Tax On My Pension?

While it is impossible to avoid paying tax on your pension withdrawals, there are certain strategies you can adopt to minimise the amount of tax you pay. One of the most effective tactics is to only take out what you need at any given time, making sure that your taxable pension income does not push you into a higher tax bracket.

Unless you have a smaller pension pot, it is rarely advisable to withdraw all of your pension funds in one lump sum. Although this might be a tempting option, it will likely push you into a higher tax band and that will almost certainly result in a large tax bill. You also run the risk of spending all your funds too early, leaving you in a precarious position should you ever need to pay for just life in general, especially if there are further cost of living rises.  

If you haven’t bought an annuity (a guaranteed income for life), one handy option is to use a flexi-access drawdown scheme. Drawdown enables you to take out variable sums of income from your pension year to year, which can help you to remain within a more favourable tax band. Drawdown also means that a portion of your pension remains invested. 

As such, your investments can go down and up, which means drawdown is not without risk. But a specialised pension adviser can provide advice and guidance to help you decide whether it is the best option for you.

How Much Of My Pension Is Tax-Free?

As mentioned earlier, the good news for pension savers is that if you have a defined contribution pension – the most popular sort – up to 25% of the pension can normally be taken tax-free. Tax-free withdrawals can be through a single lump sum or several smaller lump sums with a 25% tax-free portion. After that, the remainder of the pension income is taxed in line with income tax rates.

It is also worth noting that many final salary pensions also allow you to withdraw a tax-free lump sum and receive a guaranteed taxable income. The best thing to do is check with your provider to find out what options are available.

Do I Pay Tax On My State Pension?

If the state pension is your only source of income, you won’t have to pay any tax. This is because the maximum you can expect to receive annually from the state pension is £10,600.20, which is well within the personal allowance. 

However, that amount is unlikely to be enough for you to live comfortably – so you need to remember that any income over and above the £12,500 threshold will be subject to a tax charge at the appropriate rate.

Will I Be Taxed If I Take My Pension As A Lump Sum, And If So, How Do I Avoid This?

It depends. As mentioned above, you can take up to 25% of a pension pot tax-free. This tax-free amount can either be in one lump sum or several lump sums via drawdown. If you were to withdraw the entire value of your pension in one fell swoop, then any funds over and above the tax-free threshold would be taxable. 

Remember that you will be taxed according to your pension income for that year, which could amount to a sizeable tax bill if you cashed out everything in one go. 

If I Am Still In Work, Will This Affect How Much Tax I Will Pay?

You can continue working even after you have begun drawing your pension (although you cannot continue working for the same employer if they have provided you with a regular income from a final salary pension). As you may have gathered, any earnings from your employment will contribute towards your income for that tax year. 

So, whilst remaining in employment will help to supplement your lifestyle, if your earnings and pension income combined are likely to tip you over the personal allowance, you will have to pay tax at the applicable rate.   

Do I Need The Help Of A Financial Adviser?

Any decisions you make regarding how, when and how much you withdraw from your pension can have major implications for your short-term and longer-term financial stability. In the short term, taking more than you need in one go could lead to a hefty tax bill. In the longer term, if you’re not careful with your withdrawals in those early retirement years, you could run out of money later in life. 

A financial adviser can help you to make the best decisions for your circumstances, helping you to enjoy your pension in the most sustainable, tax-efficient way. The peace of mind you can gain from knowing that your hard-earned pension funds won’t be impacted too much by tax can often be priceless.

Pension Advice From Hilltop Financial Planning 

We hope that this article has given you a better idea of how to minimise tax on a pension. Remember that only 25% of your pension fund can be taken tax-free. Anything over and above that threshold will be taxed at the appropriate rate, depending on how much income you take. Being smart about how much you withdraw and using a flexible method like drawdown can ensure you pay less tax on your pension and have more funds to play with. 

At Hilltop, we make pension advice personal. So if you want to secure a planned future and minimise the amount of tax you pay on your pension income, our regulated pension advice can put you in the driving seat. We offer bespoke pension advice to help you make the best decisions for tomorrow – today. With the help of our regulated financial advisers, a worry-free future could be just a phone call away.

So don’t delay. Contact us on our website today or call us on 0161 413 7051 to schedule a consultation and learn more about how we can help you maximise your pension benefits while minimising your tax liabilities.

Hilltop is open 9am to 5pm Monday to Thursday and 9am to 4pm on Fridays. We are authorised and regulated by the Financial Conduct Authority, and our advisers have over 100 years of combined experience and knowledge of working with people like you and helping them to make the most of their finances.