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What Is the Tax-Free Allowance for Pensioners in the UK?

Written by, Marija Petkova

Updated April, 17, 2022

Are you retiring soon in the UK? If so, you may be wondering what is the tax-free allowance for pensioners in the UK. 

This article gives you a rundown of the personal allowance limits and how to use them to lose the least amount of money.

Stay tuned for more!

How Much of My Pension Is Tax-Free?

Many retirees believe that their pension income, particularly the state pension, will be tax-free, but that is true to an extent, and it depends on certain factors explored below.

Tax-Free Pension Allowance

In short, you won’t pay income tax on your pension in the UK if your yearly income is below or equal to the personal allowance limit, which amounts to £12,570 for the 2022-23 tax year.

If your yearly earnings go above this limit, you will have to pay the standard 20% income tax on the excess amount, up to £50,000, after which higher rate taxes apply.

Tax on а Pension Lump Sum

If you are on a contribution pension plan (or even a defined benefit pension in some cases), you can withdraw a quarter out of your pot without paying the applicable income taxes.

However, you can also take out smaller lump sums, 25% of which will be tax-free, while the rest will be added to your taxable income. 

In such cases, the remainder of your pension stays invested. By taking this route, you could reduce the tax you ultimately pay, and the remaining funds will continue growing tax-free.

Note: The number of withdrawals you can make in such cases is limited, and additional charges may apply, depending on your current pension provider.

Do I Pay Tax on My State Pension?

While UK state pensions are taxable, you will have to pay that tax only if your combined income exceeds the maximum yearly allowance of £12,570.

Therefore, since the state pension for 2021/22 is £9,339, you won’t have any tax obligations if you don’t have any other income to exceed the allowance limit.

For instance, if you were to receive an additional £9,000 income on top of your £9,339 pension, your total income would amount to £18,339, meaning you would be left with a taxable sum of £5,769 over the limit. You would have to pay £1,154 (20%) in taxes in such cases.

Can I Withdraw My Entire Pension Pot?

While you may be able to take out your whole pension as a single lump sum at 55 years of age, doing so is often a bad idea for a variety of reasons, such as paying a higher tax on your pension sum, and running out of money during your retirement as a consequence.

But, if you are seriously thinking of withdrawing your entire pot, you will most likely have to pay a higher tax rate on your pension income, which will apply to three-quarters of your full pot.

Per current UK law, the higher tax bands of 40% start at £50,271. However, if you are withdrawing over £150,000, you will be paying tax on your pension in excess of 45%.

In such instances, you should also set up additional revenue streams for you or your dependents to ensure you won’t run out of regular savings during your retirement.

Note: If you need a large sum of money for various reasons, your financial adviser may offer you alternative yet better solutions than withdrawing your whole pension, such as relying on your spouse’s pension and using various tax reliefs for married couples.

How Can I Avoid Paying Tax on My Pension?

At this point, most of you are asking yourselves: ‘How can I avoid paying these pension taxes’, or ‘How do I take advantage of the tax allowances for pensioners in the UK?’

Well, if you are withdrawing less than your pensioners tax allowance, you won’t pay any taxes, but if you need more funds, you can minimise your taxes by drawing just the right amount.

However, before dipping in your pension, you should also avoid surpassing the allotted lifetime allowance as doing so results in various tax charges.

Ultimately, it’s best to keep your money in your tax-efficient pension fund until you need it. You can set up a drawdown scheme for that purpose, which will help you vary your yearly income based on your financial needs to avoid wasting the excess amount by paying tax on it.

Note: Try to avoid annuity plans in such cases as their income is fixed year-on-year. Also, 

Bottom Line

Now that you know what is the tax-free allowance for pensioners, and that it amounts to £12,570 for 2021/22, you can minimise or avoid your tax charges by withdrawing only as much as you need or below this amount. If you need more to live comfortably or pay off a sizeable necessity, you can consult your pension adviser to find a better and cheaper solution.