Let's be honest- no one enjoys paying tax. Especially when you've worked hard, saved hard, and now want to enjoy your pension. The good news? While you can't avoid tax altogether, there are smart ways to reduce how much tax you pay on your pension and keep more of your money for the retirement you deserve.
A pension plan involves making decisions about how you manage the implications of tax on your pension savings. It primarily focuses on understanding the UK tax rules to create a strategy that aligns with your retirement goals and reduces your pension tax liability.
In this guide, we'll walk you through how pension tax works, what options you have, and how financial planning can make a big difference to your retirement savings and optimise your spending power in later life. Keep reading to learn more, or get in touch with Unicorn Accountants to skip the stress and start planning for your future.
How does tax on pensions work?
Understanding how pension tax works is the first step in reducing it. The amount of tax you pay depends on your total yearly income, which could include:
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State Pension income
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Private or workplace pensions
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Savings or investment income
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Rental income
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Any other income sources
State Pension
The new State Pension is based on your National Insurance record. This type of pension is taxable, but is generally paid without deduction of tax. HMRC collects the tax through "Pay as You Earn' (PAYE) if the total annual income, including your pension, is more than the Personal Allowance, which is £12,570 for the 2025/26 tax year.
Defined contribution pension (private pension)
Tax is paid on such pension depending on the amount withdrawn. You can withdraw up to 25% of the amount as a tax-free lump sum, with the maximum amount being £268,275 (2025/26). This is the case for any pension scheme.
Again, your Personal Allowance comes into play, but if your total income pushes you into a higher tax bracket, you'll pay 20%, 40% or 45% on anything over the allowance. Your tax code determines how much tax is deducted, so it's crucial that this is correct. Otherwise, you could pay too much tax (or not enough and face another bill later).
6 ways to reduce pension tax
There are many ways that you can avoid paying too much tax on your pension. Here are our tried and tested top tips:
1. Make the most of your personal tax allowance
Your Personal Allowance is the amount you can earn every year before you pay Income Tax. It's currently £12,570 for the 2025/26 tax year.
Understanding your allowance and finding strategies that help you minimise your tax implications will ultimately help you pay less tax. To avoid it altogether, your pension withdrawals and any other retirement income must be under the Personal Allowance tax threshold. This is where an accountant comes in to help you make sure you're utilising your tax allowance to its full potential.
2. Use your tax-free cash wisely
Under the existing rules, after reaching retirement age, individuals are allowed to take up to 25% out of their pension pot as a tax-free lump sum. Be cautious, though, because it is added to any additional income you earn during the tax year and could push you into a higher tax band.
To avoid paying tax on pension, opt for phased withdrawals instead of a lump-sum withdrawal. This means taking smaller amounts out of your pension pot over several years to help you avoid jumping into a higher tax bracket.
3. Deferring the State Pension (if it works for you)
You don't have to take your State Pension as soon as you reach State Pension age. However, it may mean you'll have less income in the short term. If you're still employed or don't need it yet, deferring could make sense.
Deferring the pension will help control when you start receiving it. It will increase your future guaranteed income and may help you reduce your taxable income now.
You must keep in mind that deferring your pension means receiving a higher amount at a later stage. When added to the total income from earnings and other sources, this may increase your taxable income at that time, so you must plan carefully.
4. Using ISAs
ISAs are Individual Saving Accounts that can be used to make tax-efficient savings and long-term investments. You can save up to £20,000 per year tax-free, and your savings grow free from Income Tax and Capital Gains Tax. You can also withdraw money whenever you need, without paying tax. But you will lose your tax-free status if you want to redeposit the money within the same tax year.
In retirement, ISAs may be especially helpful as a tax-free means to supplement income. They can be used, for instance, to supplement pension income (which is generally taxed after the first 25% of the pot) or, in some cases, to assist in filling a gap until you get a pension.
The Lifetime ISA is a specific type of Individual Savings Account that allows you to save towards retirement (or your first home). You have to be over 18 and under 40 to open a Lifetime ISA, but the benefit is that the government will contribute an additional 25% to your savings up to £1,000 per year.
5. Distribute assets efficiently
If you're married or in a civil partnership, it's worth reviewing how your assets and income are distributed. Transferring income-generating assets to the partner in the lower tax band can reduce your household's overall tax bill.
It is also necessary to think about how you will spread different asset classes across your accounts. For example, if you use an ISA, it can make more sense to use it for assets that yield dividends instead of cash. That's because the return on cash is frequently less than that from dividends over the long run.
Some individuals may get higher tax-free interest on their savings (up to £5,000 at the 'starter rate') than they would from dividends. Over time, the interest you receive from cash savings may be less than that of dividends. How this works for you might vary depending on how much you make from each, your tax status, and the kinds of investments you make.
6. Money purchase annual allowance
If you've started withdrawing from your defined contribution pension, you might trigger the MPAA, which limits future contributions to £10,000 per year with tax relief. This can affect your long-term tax strategy if you're still working or want to continue building your pension tax-free.
Understanding your pension scheme rules and planning ahead with a financial adviser or dedicated accountant like us can help you avoid unexpected tax charges.
How can tax planning with Unicorn Accountants help you?
It's critical to ensure a tax-efficient retirement. For the most savings, use this guide to make the most of what you've worked hard to build. Make good use of allowances, plan withdrawals, delay State Pensions, make use of ISAs, and allocate assets prudently.
As expert tax accountants, Unicorn Accountants is your go-to advisor for all your retirement tax strategies. Our accounting services guarantee tax-efficient pension management, from State Pension deferment to smart exit planning and allowance optimisation.
Let's talk about how we can help you reduce your pension tax. Call us today on 020 8064 0454 or send us a message, and together, we will create a retirement plan that is both tax-efficient and personalised for you!
Frequently asked questions about tax on pensions
Is pension income taxed differently from other income?
Generally, income from your pension is taxed the same as income from employment and other sources. You pay Income Tax at the same rates, but the main difference is that you don't pay National Insurance on pension income.
Can you get tax relief on pension income?
Tax relief only applies to pension contributions, not withdrawals. But it can be a great way to save more into your pension before retiring.
Should I work with an accountant to help manage pension savings?
Absolutely! We'll give you peace of mind and clarity when planning for your retirement, ensuring you make informed decisions about your retirement income. We'll help you understand how much you can withdraw and create personalised strategies that ensure you're not paying too much tax.