Pillar guide · Pension tax

How UK pensions are taxed — the complete guide.

Tax relief on the way in, tax-free growth in the middle, and income tax on the way out. Plus the annual allowance, the 60% tax trap, HICBC, inheritance rules, and the calculators to model every scenario.

By Pension Bible editorial team·Last reviewed 8 April 2026·16 min read

The three stages of pension tax

UK pension taxation follows a simple pattern that is easy to state but surprisingly hard to internalise: contributions are tax-relieved, growth is tax-free, withdrawals are taxed as income. Economists call this the EET model (Exempt-Exempt-Taxed), and understanding it is the key to every pension tax decision you will ever make.

Stage one is the way in. When you contribute to a pension, HMRC gives you tax relief at your marginal rate. A basic-rate taxpayer contributing £80 sees it grossed up to £100 inside the pension — the £20 of income tax they originally paid is refunded. A higher-rate taxpayer contributing the same £80 can claim back an additional £20 through self-assessment, making the true cost just £60 for £100 of pension investment.

Stage two is the middle. Inside the pension wrapper, investments grow completely free of income tax and capital gains tax. There is no annual reporting, no dividend tax, no CGT on rebalancing. Over decades, this tax-free compounding is enormously valuable — it is the reason pensions outperform ISAs for most higher-rate taxpayers despite the withdrawal tax.

Stage three is the way out. When you draw money from your pension (after age 55, rising to 57 from April 2028), 25% can be taken tax-free and the remaining 75% is taxed as income at whatever your marginal rate happens to be that year. If you control the timing and size of your withdrawals, the effective tax rate on the way out can be significantly lower than the relief you received on the way in — and that differential is where the real value of pension saving lives.

Tax relief on contributions

Tax relief is the headline reason pensions beat every other savings wrapper for most UK taxpayers. The mechanism works differently depending on whether you contribute through Relief at Source (RAS) or salary sacrifice, but the economic result is broadly the same.

Relief at Source (RAS)

This is how most personal pensions and many workplace schemes operate. You contribute from your net (post-tax) pay. Your pension provider adds basic-rate tax relief (20%) automatically — so if you pay in £80, the provider claims £20 from HMRC and your pension receives £100. If you're a higher-rate (40%) or additional-rate (45%) taxpayer, you claim back the extra relief through your self-assessment tax return. The additional reclaim is £20 for higher-rate taxpayers or £25 for additional-rate taxpayers, per £100 of gross contribution.

The practical implication: a 40% taxpayer who contributes £100 gross to their pension only gives up £60 of spending power. For a 45% taxpayer the cost is £55. This makes pension contributions the most tax-efficient form of saving available under UK law.

Salary sacrifice

Under salary sacrifice, you agree to reduce your contractual salary in exchange for your employer contributing the difference directly into your pension. The contribution never passes through your payslip, so it avoids income tax and National Insurance — both employee NI (8% in 2025/26 on earnings between £12,570 and £50,270) and employer NI (15% above £5,000).

The NI saving is the key advantage over RAS. A basic-rate taxpayer sacrificing £100 of gross salary saves £20 in income tax and £8 in employee NI — a total saving of £28 compared to £20 under RAS. Many employers pass on their employer NI saving too, adding roughly £15 per £100 sacrificed directly into your pension pot. We cover this in detail in our salary sacrifice guide, and you can model your own numbers with the salary sacrifice calculator.

For higher earners, there is no additional self-assessment claim needed with salary sacrifice — the saving happens at source. This makes it administratively simpler and ensures you never miss out on relief you're entitled to. Use our pension tax relief calculator to compare RAS and salary sacrifice side by side.

The 25% tax-free lump sum

When you access your pension (from age 55, rising to 57 in April 2028), you can take up to 25% of the value tax-free. The lifetime cap on this tax-free amount is £268,275 — one quarter of the old lifetime allowance of £1,073,100.

There are two ways to take your tax-free cash, and they work differently:

Crystallised drawdown (PCLS)

You "crystallise" a chunk of your pension — say £100,000 — take 25% (£25,000) as a tax-free lump sum, and move the remaining 75% (£75,000) into drawdown, where it stays invested and you draw income as needed. That income is taxed at your marginal rate. This is the most common approach for people entering flexible drawdown.

Uncrystallised funds pension lump sum (UFPLS)

You take a lump sum directly from your uncrystallised pension. Each withdrawal is 25% tax-free and 75% taxable. So a £10,000 UFPLS withdrawal gives you £2,500 tax-free and £7,500 taxable. This is simpler mechanically but offers less control over timing. You can model the tax impact of different UFPLS withdrawal sizes with our pension lump sum tax calculator.

The important point: both methods draw from the same £268,275 lifetime lump sum allowance. Once you have taken £268,275 of tax-free cash across all your pensions combined, every subsequent withdrawal is fully taxable. For most savers this cap will never bite, but for those with pots above roughly £1.07 million it becomes a binding constraint.

Income tax on pension withdrawals

The 75% of your pension that isn't tax-free is taxed as earned income. It stacks on top of your other income — state pension, employment income, rental income, savings interest — and is taxed at whatever marginal rate that total puts you in.

This is where retirement tax planning matters most. If you withdraw £50,000 from your pension in a year when you have no other income, the first £12,570 is covered by your personal allowance (0% tax), the next £37,430 is taxed at 20%, and your total tax bill is about £7,486 — an effective rate of roughly 15%. But if you withdraw the same £50,000 in a year when you're also receiving a £30,000 salary, the entire pension withdrawal sits in the basic or higher-rate band, and your effective rate on the pension income jumps to 20-40%.

Emergency tax — the Month 1 trap

When you take your first pension withdrawal, the provider often does not have your tax code from HMRC. In that case they apply an "emergency" tax code on a Month 1 basis — meaning they calculate tax as if your withdrawal is one month's income and extrapolate it to an annual figure. A single £20,000 withdrawal can be taxed as if you earn £240,000 per year, resulting in a deduction of 40% or even 45%.

The money is not lost — you can reclaim the overpayment from HMRC using form P55 or P50Z, or it will be corrected when HMRC issues an updated tax code. But the delay can be weeks or months, and it catches thousands of new retirees off guard every year.

The annual allowance

The annual allowance limits how much you (and your employer) can contribute to pensions in a single tax year with tax relief. For 2025/26 it is £60,000 or 100% of your UK earnings, whichever is lower. Contributions above this limit trigger an annual allowance charge, which effectively claws back all the tax relief at your marginal rate.

Tapered annual allowance for high earners

If your "adjusted income" (broadly, total income including employer pension contributions) exceeds £260,000, the annual allowance tapers down by £1 for every £2 of income above that threshold. The minimum tapered allowance is £10,000, which kicks in at adjusted income of £360,000 and above. Your "threshold income" (income excluding pension contributions) must also exceed £200,000 for the taper to apply.

The taper creates a cliff-edge. A saver with adjusted income of £259,999 has a full £60,000 allowance. At £260,001, the allowance drops to £59,999. At £360,000+, it is just £10,000. This makes pension contribution planning essential for anyone with income in the £200,000-£360,000 range.

Money Purchase Annual Allowance (MPAA)

Once you flexibly access a defined contribution pension — by taking income from drawdown or an UFPLS (but not by taking your tax-free lump sum alone) — your annual allowance for money purchase contributions drops permanently to £10,000. This is the MPAA, and it cannot be reversed.

The MPAA does not affect defined benefit accrual, and it does not affect contributions your employer makes to a defined benefit scheme. But it does mean that anyone who starts drawing pension income before they stop working faces a dramatically reduced ability to save into a pension going forward. Use our MPAA calculator to check whether the MPAA applies to you and what it means for your contribution room.

Carry forward

If you did not use your full annual allowance in the previous three tax years, you can carry forward the unused amount and add it to the current year's allowance. This is enormously useful for savers with lumpy income — a bonus year, a property sale, a redundancy payment — who want to make a large one-off contribution.

The rules: you must have been a member of a registered pension scheme in each year you carry forward from (even a scheme with zero contributions counts), and your gross contribution in the current year cannot exceed your UK earnings. The carry forward is used in chronological order, oldest year first.

For a saver who made zero pension contributions in the previous three years and earns at least £240,000, the maximum contribution in 2025/26 is up to £240,000 (£60,000 current year plus £60,000 from each of the three preceding years). Our carry forward calculator models the exact available amount based on your contribution history.

The 60% tax trap

Between £100,000 and £125,140 of taxable income, the personal allowance is withdrawn at a rate of £1 for every £2 of income above £100,000. This creates an effective marginal tax rate of 60% on income in that band — 40% income tax plus the 20% effect of losing £1 of personal allowance (which was sheltering income from 40% tax) for every £2 earned.

The maths: every additional £2 of income above £100,000 costs you £0.80 in tax on the £2 itself (40%) plus £0.40 in lost personal allowance (£1 of allowance withdrawn, which was saving you 40% tax). Total tax on £2 of income = £1.20. Effective rate = 60%.

This is not a quirk — it affects roughly 1.5 million UK taxpayers in 2025/26 and rising. And pension contributions are the single most effective legal method of eliminating it. A saver with income of £125,140 who contributes £25,140 to their pension reduces their adjusted net income to £100,000, restores the full £12,570 personal allowance, and saves approximately £12,570 in tax that would otherwise be lost to the taper — on top of the 40% relief on the contribution itself.

The effective tax relief on pension contributions made within this band is not 40%. It is closer to 60%, because the contribution simultaneously attracts 40% relief and restores personal allowance that was being clawed back. For a saver who plans to withdraw pension income below the higher-rate threshold in retirement, the round-trip tax benefit can exceed 40 percentage points. Our 60% tax trap calculator models the exact saving for your income level.

High Income Child Benefit Charge (HICBC)

If either partner in a household has adjusted net income above £60,000 and the household claims child benefit, the higher earner must pay back a proportion of the benefit through the High Income Child Benefit Charge. The clawback is 1% of the child benefit received for every £200 of income above £60,000, reaching 100% at £80,000.

For 2025/26, child benefit is £26.05 per week for the first child and £17.25 for each subsequent child. A two-child family receives roughly £2,257 per year. A higher earner with income of £70,000 would repay 50% of this — about £1,128 — through self-assessment.

Pension contributions reduce adjusted net income. A saver earning £75,000 who contributes £15,000 to their pension (gross) reduces their adjusted net income to £60,000, eliminating the HICBC entirely. The pension contribution attracts 40% tax relief (£6,000) and preserves the full child benefit (£2,257 for two children) — a combined tax benefit of £8,257 on a £15,000 contribution, which is an effective relief rate of 55%.

This is one of the clearest cases where pension contributions produce returns far above the headline tax relief rate. Use our HICBC pension calculator to see the combined tax and child benefit saving for your specific income and number of children.

Pension inheritance tax

Pensions sit outside your estate for inheritance tax (IHT) purposes — they are not included in the value of your estate for the standard £325,000 nil-rate band calculation. This makes them one of the most tax-efficient assets to leave to the next generation, and it fundamentally changes the optimal drawdown strategy for retirees with other assets.

The age-75 boundary

The tax treatment of inherited pension funds depends on the age of the pension holder at death:

Death before age 75: The entire pension fund can be passed to beneficiaries completely tax-free, whether taken as a lump sum or as income. There is no income tax and no IHT. This is one of the most generous provisions in UK tax law.

Death at age 75 or later: Beneficiaries pay income tax at their own marginal rate on any withdrawals from the inherited pension. There is still no IHT — the fund remains outside the estate — but the income tax means the effective inheritance rate depends on the beneficiary's tax band. A basic-rate beneficiary withdrawing £30,000 per year would pay 20% income tax, retaining 80% of the fund value over time.

The strategic implication: for retirees with ISAs, property, or other assets alongside their pension, it is often more tax-efficient to spend down non-pension assets first and preserve the pension as long as possible. If you die before 75, the pension passes entirely tax-free. If you die after 75, it still avoids IHT (currently 40%) and is only subject to the beneficiary's income tax rate, which may be lower than IHT would have been.

This creates a strong argument for keeping money inside pensions rather than withdrawing it unnecessarily — especially for those who do not need pension income to fund their retirement spending. Our pension inheritance calculator models the tax-free versus taxable scenarios for different death ages and beneficiary tax bands.

Important note: The government announced in the Autumn Budget 2024 that unused pension funds will be brought into the scope of IHT from April 2027. If implemented, this will significantly change the inheritance planning landscape. We will update this guide when the legislation is finalised.

Income tax in retirement

Many retirees are surprised to discover that the state pension is taxable income. For 2025/26, the full new state pension is £11,973 per year — just under the £12,570 personal allowance. That leaves only £597 of personal allowance to shelter other income before basic-rate tax kicks in.

This has a cascading effect. If you have a workplace defined benefit pension of £8,000 per year on top of your state pension, your total income is £19,973. After deducting the £12,570 personal allowance, £7,403 is taxable at 20%, producing a tax bill of roughly £1,481. The state pension itself isn't taxed at source (it's paid gross), so the tax is usually collected by adjusting the tax code on your other pension or through self-assessment.

For retirees with multiple income sources — state pension, DB pension, private pension drawdown, rental income, part-time work — the interaction between these sources determines both the marginal rate on each additional pound withdrawn and the optimal drawdown strategy.

Model your retirement income tax

Use the calculator below to see how your combination of retirement income sources stacks up. Enter your state pension, any defined benefit pension, planned drawdown, and other income to see the total tax bill and effective rate.

The key insight from modelling retirement income is that timing matters as much as total amount. Withdrawing £20,000 per year from your pension over five years produces a very different tax outcome from withdrawing £100,000 in a single year — even though the total is identical. Spreading withdrawals across tax years to stay within lower bands is the core principle of retirement income tax planning. Our income tax in retirement calculator lets you experiment with different withdrawal strategies.

Scottish taxpayers

Scotland sets its own income tax rates and bands, which differ from the rest of the UK. For 2025/26, the Scottish rates are:

Scottish taxpayers receive pension tax relief at their Scottish marginal rate, which means the relief can differ from the rest-of-the-UK rates. A Scottish intermediate-rate taxpayer gets 21% relief (not 20%), while a Scottish higher-rate taxpayer gets 42% relief (not 40%). The personal allowance and personal allowance taper remain UK-wide and are unchanged.

The practical difference for most Scottish pension savers is modest. The biggest divergence is at the top: Scottish top-rate taxpayers pay 48% and receive 48% pension tax relief, compared to 45% for additional-rate taxpayers elsewhere in the UK. The advanced rate band (45% on £75,001-£125,140) also means Scottish taxpayers hit a higher marginal rate sooner than their English or Welsh counterparts.

All of our calculators support Scottish tax rates — select "Scotland" when prompted.

FAQ

How much tax relief do I get on pension contributions? You receive tax relief at your marginal income tax rate. Basic-rate taxpayers get 20% relief (contributed automatically under Relief at Source). Higher-rate taxpayers get 40% — 20% automatically, plus 20% claimed through self-assessment. Additional-rate taxpayers get 45%. Through salary sacrifice, you also save on National Insurance contributions, which increases the effective relief further. Use our pension tax relief calculator to see your exact relief.

Is my state pension taxable? Yes. The state pension is taxable income, though it is paid gross (without tax deducted at source). For 2025/26 the full new state pension is £11,973 — just below the £12,570 personal allowance. Any other taxable income on top of your state pension will start being taxed at 20% almost immediately.

What is the 60% tax trap and how do I avoid it? Between £100,000 and £125,140 of income, your personal allowance is withdrawn at £1 for every £2 of income above £100,000. Combined with the 40% tax rate, this creates an effective marginal rate of 60%. The most common way to mitigate it is to make pension contributions that reduce your adjusted net income to £100,000 or below. See our 60% tax trap calculator for the specific numbers.

What happens to my pension when I die? Under current rules (2025/26), pensions are outside your estate for IHT. If you die before 75, beneficiaries receive the fund tax-free. If you die at 75 or later, they pay income tax at their marginal rate on withdrawals. From April 2027, the government plans to bring pensions into scope for IHT, which would change this significantly. Model the current rules with our pension inheritance calculator.

What is the Money Purchase Annual Allowance? The MPAA is a reduced annual allowance of £10,000 that applies once you flexibly access a defined contribution pension (for example, by taking income from drawdown). It is permanent and cannot be reversed. Taking your 25% tax-free lump sum alone does not trigger it, but taking any taxable income from a flexi-access drawdown or UFPLS does. Check your position with our MPAA calculator.

Can I carry forward unused annual allowance from previous years? Yes. You can carry forward unused annual allowance from the three previous tax years, provided you were a member of a registered pension scheme in each of those years. The current year's allowance is used first, then the oldest carried-forward year. This can allow contributions of up to £240,000 in a single year for someone who has used none of their allowance in the previous three years and has sufficient earnings. Use our carry forward calculator to check your available allowance.

How do pension contributions reduce my HICBC liability? Pension contributions (whether personal or through salary sacrifice) reduce your adjusted net income. If your adjusted net income is above £60,000 and you receive child benefit, reducing it below £60,000 through pension contributions eliminates the HICBC entirely. Even partial reductions save money — every £200 reduction in income below £80,000 reduces the charge by 1% of your child benefit entitlement. See our HICBC pension calculator for your specific saving.

How does pension tax compare to fees in terms of impact? Both are major determinants of retirement outcomes. Tax is potentially recoverable through relief (contributions) and planning (withdrawal timing), while pension fees are a pure drag on growth. The optimal approach addresses both: maximise tax relief on the way in, minimise fees during the growth phase, and plan withdrawals to minimise tax on the way out.

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Pension Bible is an editorial publication, not a financial adviser. The information in this guide is general guidance based on publicly available data from HMRC and gov.uk. Tax rules can change and individual circumstances vary. For personal recommendations about your specific pension and tax situation, speak to an FCA-regulated financial adviser. You can find one through Unbiased or VouchedFor.