The call came at 7:43 AM. David. Retired six months after forty years of corporate service. “Grace, are pensions taxed in retirement? They have deducted £200 from my payment.”
His voice was tense, confused, and angry.
“I thought retirement was tax-free.”
Three days later, Margaret called. Former teacher. She had taken out £50,000 to help her daughter purchase a house.
“Grace, I’ve got a tax demand for £4,286. This has to be a mistake.”
It wasn’t.
These calls reveal Britain’s most expensive retirement myth: that your pension remains untouched.
It doesn’t.
(I’m a Chartered Accountant; I am not a pension or tax adviser. As always, for personalised advice, consider consulting with a qualified professional.)
The Quick Answer
Are pensions taxed in retirement? Yes, and most people are unaware of this.
The first £12,570 is tax-free; then, a tax rate of 20-45% applies.
The State Pension doesn’t deduct tax directly; another pension provider collects the whole amount.
Withdrawing large lump sums beyond your 25% tax-free allowance can push you into higher tax brackets.
However, with proper planning, you can legally minimize the losses.
Myth #1: Are Pensions Taxed in Retirement? (The Answer Shocks Most People)
David’s dilemma: “I have been a taxpayer for 40 years. Why are they continuing to take it?”
The reality: Your pension is a form of income. Income gets taxed. Always.
How it works:
£12,570 is the Personal Allowance. (Income Tax Rates 2025/26)
Above that:
- £12,571–£50,270 → 20% tax
- £50,271–£125,140 → 40% tax
- Over £125,140 → 45% tax
David’s numbers:
Annual pension: £15,000
Tax-free: £12,570
Taxable: £2,430
Annual tax: £486
Your numbers might look like:
- £20,000 pension → £1,486/year in tax
- £30,000 pensions → £3,486 a year tax
- £60,000 pension → £9,486 /year tax
What if you have other income?
Sarah, 67, had:
State Pension: £11,500
Private Pension: £18,000
Rental income: £8,000
Total: £37,500
HMRC added them all together. Tax bill: £4,986/year. All on her private pension.
Where your income comes from is irrelevant to HMRC. They add it all up and tax the whole.
Myth #2: The State Pension is tax-free.
Why David felt his provider was ripping him off:
He was getting:
State Pension: £11,500
Civil Service Pension: £15,000
Total: £26,500
However, deductions appeared only on his civil service pension.
The State Pension is taxable. But HMRC informs your other pension provider to tax the income from both pensions.
David’s real tax:
Total income: £26,500
Tax-free: £12,570
Taxable: £13,930
Tax bill: £2,786/year
All collected through his civil service pension.
What if you receive the State Pension?
You’ll receive a Self Assessment tax return from HMRC. Payments are made annually, not monthly.
Your provider isn’t trying to make extra money. HMRC is just covering your State Pension cost.
Myth #3: Your Pension Pot is Tax-Free Cash.
Margaret’s £50,000 shock:
She withdrew £50,000 from her £120,000 pension pot. She’d heard: “Take 25% of your pension pot tax-free!
“But only 25% of your pot is tax-free,” I explained. “That’s £30,000. Then it becomes income.”
She went silent after I explained that:
- £30,000 (25% of the pot) = tax-free
- £20,000 (the excess) = taxed as income
But Margaret also had a teacher’s pension, £14,000 a year.
HMRC saw:
Teacher’s pension: £14,000
Taxable withdrawal: £20,000
Total: £34,000
Her tax bill: £4,286
“But I was just helping my daughter,” she murmured.
The 25% promise? That’s only part of the story.
Myth #4: All Pension Tax Is The Same
David (Final Salary Pension):
Set income for life
Tax deducted monthly
Predictable
Margaret (Pension Pot):
She controls withdrawals
Every withdrawal triggers tax
Take too much? Jump tax bands
Not sure which you have?
Final Salary = “defined benefit” / secure £X per annum
Pension Pot = “defined contribution” or total value of £X pot
Same income, different worlds:
Two retirees. Both get £20,000/year.
Person A (salary at end): £1,486 tax/year
Person B (Withdraws £40,000 just once): Tax bill of £6,000
Red Flags You’re Wasting Money
Tick any that apply:
- Your pension payment is smaller than you thought it should be
- You’re about to withdraw a hefty lump sum without advice
- You’ve got multiple income streams (rental, dividends, part-time job)
- Tax code isn’t 1257L
- You took money out and faced an unexpected tax bill
- You’re married, but only one of you is using your tax-free allowance
If you checked ANY, read on.
Myth #5: I Can’t Do Anything About It
“So I just accept it?” David asked. “No. You can’t avoid tax. But you CAN control it.”
6 ways to keep more:
- Don’t take considerable lump sums. Spread £50k over 3-5 years, not all in one go. Stay in the 20% band.
- Remain close to £12,570. Some years, rely on savings. Keep pension income low. Pay zero tax.
- Leverage ISAs first – Withdrawals from an ISA = tax-free. Use these in high-income years.
- Couples: share allowances, balance income contributions between you. Use both tax-free allowances.
- Seek help before withdrawing – Margaret’s error cost £4,286. An adviser costs £200-300.15x return.
- Track your other income: rental income, dividends, and part-time work all count. Sarah’s rental boosted her tax by £1,600.
Read our article on How to Create a Happy Retirement Budget Without Compromise for further guidance.
Quick wins:
- Confirm your type of pension (statement or online account).
- Calculate total retirement income (State + private + other)
- Complain to HMRC if your tax code appears wrong.
- Book a free Pension Wise appointment (gov.uk) for over-50s government service.
Common “What If…” Questions
Q: What if I inherit money?
A: Inheritances aren’t taxed. But interest/dividends from investing it ARE taxable.
Q: What if I work part-time?
A: That income is in addition to pension pay.
Total Sum = pension + State Pension + earnings. A £10,000 job comes with a potential £2,000+ tax bill.
Q: What if my pension is under £12,570?
A: Zero tax. If you also have a State Pension (£11,500), your combined amount would exceed £12,570, and this would result in you paying tax.
Q: What if I move abroad?
A: UK pension tax rules still apply except for a few tax treaties. Get specialist expat advice.
Why This Actually Matters
A week later, David texted:
“Just worked it out. If I had known about pension tax in retirement five years ago, I would have saved nearly £10,000. Wish I’d known.”
Margaret said three weeks later. “I shared everything with my sister. She was about to withdraw £60,000 in one go. She’s taking her £30,000, tax-free upfront, then spreading the rest over three years. You saved her £6,000”.
The question “Are pensions taxed in retirement?” is asked by most individuals only after their first check arrived a little lighter than expected. And by then, it is too late to really plan well.
The tax bill isn’t the real trap. It’s discovering it when it’s too late to plan.
The Truth About Pension Tax in Retirement
When people ask me if pensions are taxed in retirement, I tell them what I told David and Margaret.
Retirement isn’t about dodging tax. It’s about managing it:
- Understand what hits your account
- Plan withdrawals according to tax bands
- Use every legal allowance
- Sleep without panicking
Retirement isn’t tax-free. But it can be freedom-rich.
Final Answer: Do You Pay Tax on Your Pension in Retirement?
Yes. Always.
David learned at 7:43 AM. Margaret took a lesson from a £4,286 bill. Sarah discovered the missing income from her pension.
You’re learning now.
Meaning you still have time to get ready.
Don’t get caught unprepared like David and Margaret. Sign up for the RetireFulfilled Newsletter and learn how to keep more of your pension each month.
