Tax and your pension

Like any other income you receive, there are tax considerations to keep in mind when you’re choosing how you’d like to receive the income from your pension savings.

There are also tax limits and allowances to be aware of when you’re still building up your pension savings.

1. When you take your pension savings: Lump Sum Allowance and Lump Sum & Death Benefit Allowance

   This is a limit on the amount of tax-free cash you can take from your pension savings across all your pension pots. The standard Lump Sum Allowance is £268,275, although this maybe higher if you have pension protection from HMRC. Taking tax-free cash from your pension will also reduce your Lump Sum and Death Benefit Allowance; the amount that can be paid tax-free to your beneficiaries on your death. The standard Lump Sum and Death Benefit Allowance is £1,073,100, but it may be higher if you have pension protection.

2. When you receive your retirement income: income tax

   You can normally take up to 25% of your pension savings as tax-free cash. Any money you then receive as an income – whether regular, flexible or as cash lump sums – will be taxed accordingly,

   You may also pay income tax on your State Pension, any salary you’re receiving alongside your retirement income, and any other taxable benefits. Your income tax band will be determined based on all your income added together, which could push you into a higher tax band than you’re used to. If you’re unsure about how you might be taxed in retirement, and how it could affect you, speak to a financial adviser.

3. While you’re still paying-in to your pension:

   The Annual Allowance

   The Annual Allowance is the total amount that can be paid towards your pension savings each year, without paying a tax charge. It’s currently £60,000. That’s a total amount that applies across all your pension pots, including any workplace pension savings you might have.

   Any contributions made above the Annual Allowance will be taxed at the highest rate of tax you pay (based on your income).

   Remember: if you take your money as flexible income or cash, from that point onwards, your annual allowance (the amount you can pay into a pension each year without a possible tax charge) will change. You’ll have a specific annual allowance in respect of your money purchase pension savings (the ‘money purchase’ annual allowance or MPAA), of £10,000. 
   
   If you have taken benefits using Capped Drawdown and you have not designated any funds to flexible income drawdown this limit may not apply and you may still be able to pay in up to the full Annual Allowance of £460,000.
   
   Embark will let you know if you have triggered this, and what you need to do next.

   The Tapered Annual Allowance

   If your total income in a year is more than £260,000, your Annual Allowance will start to reduce by £1 for every £2 you earn over that amount.

   This is one of the more complicated areas of pension saving. But the government has put together a helpful step-by-step guide to working out if and how you’ll be affected, that you can access here. If you earn £200,000 or less, it won’t affect you at all.

   Important: you might see the phrase ‘Relevant Benefit Crystallisation Event’ used in relation to the Lump Sum Allowance and Lump Sum & Death Benefit Allowance. That’s the name for an event where you received tax-free cash from your pension to make sure you’re not exceeding the allowances.