How is money taxed when I take income from pension drawdown?

Full answer

Pension drawdown gives flexibility over how and when you take retirement income from a defined contribution pension, but withdrawals beyond the tax-free element are taxed as income, which makes the timing and size of withdrawals an important planning consideration. **The tax-free element** When you move pension funds into flexi-access drawdown, you can normally take up to 25% of that amount as a tax-free lump sum (subject to the overall Lump Sum Allowance of £268,275), either all at once or in stages, with the remaining 75% (or whatever proportion you choose not to take tax-free) staying invested in the drawdown fund. **How withdrawals from the taxable portion are taxed** Any income you then draw from the remaining taxable portion of the drawdown fund is added to your other taxable income for that tax year (such as any part-time earnings, State Pension, or other pension income) and taxed at your marginal Income Tax rate -- there is no separate, lower 'pension income' tax rate; it is simply added to your total income and taxed under the normal bands. **Worked example** Someone with no other income withdraws £20,000 from the taxable portion of their drawdown pot in a tax year. The first £12,570 is covered by their Personal Allowance (tax-free), and the remaining £7,430 is taxed at the 20% basic rate, resulting in Income Tax of £1,486 on that withdrawal. **The Money Purchase Annual Allowance trigger** Once you take ANY taxable income from drawdown (not just the tax-free lump sum on its own), your future pension annual allowance for money purchase contributions drops to the Money Purchase Annual Allowance of £10,000 a year, significantly restricting how much further tax-relieved pension saving you or an employer can do on your behalf afterwards. **Large single withdrawals and emergency tax** A large one-off drawdown withdrawal is often initially taxed using an emergency, non-cumulative tax code by the pension provider, which can result in significant over-taxation in that pay period, later reclaimable from HMRC -- this is a common surprise for people taking a large lump sum from the taxable portion in one go. **Practical tip** Plan drawdown withdrawals across tax years where possible to avoid pushing yourself into a higher tax band unnecessarily in a single year, and be aware that taking any taxable drawdown income (not just tax-free cash) permanently restricts your future annual allowance via the MPAA.

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More answers

• How does the tapered pension annual allowance work for high earners?
• Can I cash in a small pension pot as a lump sum without triggering the Money Purchase Annual Allowance?