How to avoid paying tax on your pension in the UK

Paying tax on your pension is often unavoidable, but with careful planning, you can significantly reduce your liability or even eliminate it entirely.

This guide explains how UK pension tax works and outlines strategies to help you keep more of your retirement income.

Do you pay tax on your pension? 

Yes, you’ll have to pay income tax on pension income, just like other kinds of income. You won’t pay national insurance (NI) on pension income because it is only paid on earned income. 

Everyone has a personal allowance (£12,570 for the 2025/26 tax year), which is the amount of income you can enjoy each year before income tax is due.  

Then, you pay basic rate tax (20%) on income between £12,571 and £50,270, at which point higher rate tax (40%) kicks in. 

If you have income over £125,140, you pay 45% tax as an additional rate taxpayer. 

How can I avoid paying tax on my pension? 

How much tax you pay will depend on your overall income, the amount of money you take out of your pensions and how you take it. 

However, while you cannot completely avoid paying tax on your pension, there are several strategies to legally minimise your tax burden, these include: 

• Taking your 25% tax-free lump sum 

• Using pension drawdown to manage your taxable income 

• Splitting your income sources 

• Keeping your income below tax thresholds 

• Being mindful of annuities 

• Planning for inheritance tax changes 

• Deferring your State Pension 

Below we go into more detail about each strategy. 

Maximise your tax-free lump sum  

If you have a defined contribution pension, you can take up to 25% of your pot tax-free, up to a maximum of £268,275. The remaining 75% is subject to income tax. 

By carefully planning when and how you withdraw your tax-free lump sum, you can reduce the tax impact on your overall income.  

For example, it may be tax-effective to take your tax-free cash in stages -  using it to supplement your income - rather than taking it all in one go.  

It is possible to do this either when you move money into income drawdown or when you buy an annuity. 

If you take out a lump sum from your pension, without going into drawdown or buying an annuity, you will get the first 25% paid tax-free, and the remainder will be added to your income for the year and taxed accordingly.  

Use pension drawdown to manage your taxable income  

If you opt for pension drawdown, you can take out only what you need each year, ensuring that you remain within the lower tax bands. 

This strategy gives you flexibility to adjust your income based on tax thresholds, helping you pay as little tax as possible.  

Split your income sources  

You can also limit your tax bill by taking money from non-taxable sources, in addition to your pension. 

For example: 

• Individual savings accounts (ISAs): Any interest, income or capital gains from investments are tax-free. 

• Personal savings allowance: This allows tax-free interest up to £1,000 for basic rate taxpayers or £500 for higher rate taxpayers. Additional rate taxpayers don’t have a personal savings allowance. 

• Dividend allowance: You can earn up to £500 in dividends tax-free.  

It’s been estimated that retirees who rely solely on their state pension will likely pay income tax from April 2027, as the personal allowance has been frozen, but the state pension keeps rising every year. 

Keep your income below tax thresholds  

If you can manage your pension withdrawals carefully and keep your taxable income below £12,570 (the personal allowance), you won’t pay any income tax.

Alternatively, by keeping your income below £50,270 each year, you can avoid paying higher-rate income tax. 

Also, bear in mind that any additional lump sum withdrawals may push you into a higher rate tax bracket.  

Be mindful of annuities  

If you choose an annuity, your pension income will usually remain the same (unless it rises with inflation) and, depending on your overall income, may push you into a higher tax bracket. 

Plan for inheritance tax changes  

Currently, pensions do not form part of your estate when you die, which means that they are not subject to inheritance tax (IHT). 

However, that is set to change from April 2027, when pensions may become subject to IHT, depending on the overall value of your estate. 

If you are worried about IHT, it’s crucial to get financial advice to plan accordingly. 

There are many ways to reduce the amount of tax your loved ones will pay, but it’s worth talking to a financial adviser about which option is best for you. 

Consider deferring your state pension 

Delaying your State Pension can increase the amount you receive when you do start claiming it.

Additionally, deferring your State Pension means you won't pay tax on it during the deferral period, which can be beneficial if you're still working or have other income sources. 

The longer you live the more valuable deferring gets, but if you live for significantly shorter than average it is unlikely to be worth it. 

What is the 60% tax trap and how can you legally avoid it?

If you’re a higher-rate taxpayer, defined as those earning between £50,271 and £125,140 annually, you may be hit by a stealthy 60% tax bill. 

This is because your personal allowance, which is £12,570 for the 2025/26 tax year, begins to fall when you earn over £100,000. 

Essentially, your personal allowance is reduced by £1 for every £2 you earn over £100,000. Once you earn £125,140 or more, your allowance disappears entirely.  

Due to the tapering of your personal allowance, every £100 you earn between £100,000 and £125,140 is reduced to £40, as you lose an additional £20 via the reduced allowance.

Can I legally avoid the 60% tax trap?

One of the best ways to avoid 60% tax is to pay into a pension or increase your payments if you’re already contributing. 

By paying more into a pension, you reduce your adjusted net income and can either reduce the amount of personal allowance you lose or even reinstate it fully if your income falls to £100,000 or less. 

Get expert financial advice 

Tax laws and pension regulations can be complex and subject to change.

Consulting with a qualified financial adviser can help you navigate your options and develop a strategy tailored to your circumstances.  

By understanding your allowances and carefully planning your withdrawals, you can minimise or even avoid paying tax on your pension, ensuring you make the most of your retirement income. 

Let Unbiased match you with a financial adviser for expert advice on managing your pension withdrawals and minimising your tax liability.