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Record numbers of retirees are paying tax on their pensions. The combination of the state pension triple lock, which has kept retirement income rising, together with frozen tax thresholds, means the ‘tax-free retirement’ is fast becoming a myth.
Steve Webb, partner at pension consultants LCP, says the situation is rapidly changing, thanks to “a combination of a multi-year freeze on income tax allowances and some large cash increases in the value of the state pension due to the triple lock”.
Here is the detailed guide to how the taxman targets your pension – and the expert steps you can take to protect your cash.
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The state pension has always been taxable income. However, until recently, it was usually low enough to sit beneath the personal tax-free allowance (frozen at £12,570).
That is changing. In April, the full state pension will reach £12,547.60 a year. This leaves a tiny buffer of just £22.40. If you have other income – even a tiny private pension – you will likely become a taxpayer. (Savings interest alone won’t make you a taxpayer, unless you have big savings. That’s because the starter rate for savings means you can get up to £18,570 a year from income and savings combined, without becoming a taxpayer.)
Steve Webb adds: “It is perfectly possible for someone with an old basic pension and a significant additional state pension (SERPS) to already be over the tax threshold.”
If the state pension is your only income over the limit, you do not usually need to file a tax return. Steve Webb explains: “Instead HMRC uses a process called ‘simple assessment’ where they do all the sums for you and send you a bill; and for relatively trivial annual bills they probably won’t even bother.”
From April 2027, the government plans to launch a ‘state pension waiver’. This will exempt pensioners whose only source of income is the state pension (basic or new) from paying the small amount of tax due on the excess.
Your private pension income is added to your state pension and taxed at your “marginal rate” – the highest rate of income tax you pay. This will be 20, 40 or 45% in England, Wales and Northern Ireland. There are 6 bands from 19 to 48% in Scotland.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, explains that if you are in receipt of a workplace pension and are required to pay tax, then this will usually be taken automatically from your pension.
This will also take into account any tax that’s payable on your state pension.
Not all of your private pension will be taxable. You can usually take up to 25% of the value of your pension as tax-free cash when you start accessing it.
Most people can start taking money out of your pension from age 55 (rising to age 57 from April 2028).
If you are accessing a private pension for the first time, beware. HMRC often applies an ‘emergency’ tax code to your first withdrawal, assuming you will receive that same amount every single month. This can result in people paying too much tax on that first pension withdrawal.
Helen Morrissey says: “This overpayment will be repaid eventually and you can fill in a form to reclaim it more quickly. However, it’s a source of frustration for many retirees and can cause financial issues if they receive less than they need to finance something like a holiday or home renovations, for instance.”
Since April 2025, HMRC has tried to improve this by automatically placing customers on a ‘cumulative code’ to prevent errors at year-end. Helen Morrissey says: “It’s a welcome change that will improve things for those taking a regular income in retirement, though those taking larger lump sums may still face issues. It’s all going to take time.”
Action: If you are overtaxed, reclaim it immediately using form P55, or , if you've emptied your pension, form P53Z , on the government website.
Currently, if you die, unspent pension pots from defined contribution pensions usually fall outside your estate and are inheritance tax (IHT) free.
From April 2027, this changes. Pension pots will be dragged into your estate, meaning your family could face a 40% tax bill on your unspent savings. But there are steps you can take to reduce the bill.
This includes giving money away during your lifetime to reduce the taxable value of your estate and there are various tax-free gifting allowances you can take advantage of. Another option you might want to explore is using a whole of life insurance policy to pay the bill.
You are not alone in this. Thanks to ‘fiscal drag’, the number of tax-paying pensioners is soaring. By 2027/28, almost half of the 17.9 million people expected to start paying income tax will be over 60 or retired. That’s according to data that wealth manager Quilter obtained in April 2025 from HMRC through a Freedom of Information (FOI) request.
And, following the extension of the freeze on tax thresholds from 2028 to 2031 (announced in the Budget 2025), the tax paid by pensioners is only going to grow. Pension consultant LCP has forecast that as many as 10m pensioners will be paying income tax by 2030. This compares to 8.7m today and 6.7m in 2021/22 when thresholds were first frozen.
The number of pensioners paying higher rates of tax has also doubled as a result of fiscal drag to just over a one million, during that time frame.
Instead of moving your whole pot into drawdown, you can leave it untouched and take ad-hoc lump sums known as UFPLS (uncrystallised funds pension lump sums).
Rachel Vahey, head of public policy at AJ Bell, explains why this works: “Using UFPLS to gradually access their pension pot offers individuals the ability to control when and how much tax-free cash they choose to take (which may depend on their other income). And their remaining unaccessed pension pot stays invested, continuing to (hopefully) grow in value.”
This allows you to “drip feed” your income to stay below higher tax bands.
Rachel Vahey adds: “By using a combination of tax-free cash, drawdown and UFPLS, pension savers really can take exactly the right amount of taxed and tax-free funds they need from their pension and cut down on their tax bills.”
Money taken from an ISA is 100% tax-free. If taking extra money from your pension would push you into the 40% tax bracket, stop. Take the extra cash from your ISA instead.
If you are married or in a civil partnership, you could save £252 a year – and claim back over £1,000 in backdated cash.
Eligibility checklist:
If eligible, the lower earner transfers £1,260 of their personal allowance to the higher earner. If you or your partner were born before 6 April 1935, you might benefit more as a couple by applying for married couple’s allowance instead.
Action: You can backdate this claim for up to four years. Apply online on the government website, though a backdated claim must be made by post.
Saga has partnered with HUB Financial Solutions, who can help you find the right annuity for you from the whole of market. If you take out an annuity using their service, Saga Money will earn a commission.
A mixture of both annuity and drawdown could give you the best of both worlds for your retirement income.
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