How to Avoid Paying Tax on Your Pension – UK Guide

Learn how to reduce pension tax legally. Discover tax-free allowances, pension drawdown strategies, ISAs and tax-efficient ways to withdraw your retirement savings.

When you start withdrawing from your pension, you may be required to pay income tax on some or all of it. However, with careful planning, you can legally reduce or even avoid paying tax on your pension, allowing you to keep more of your retirement savings.

This guide explains the best strategies to minimise pension tax, including how to make the most of tax-free allowances, flexible withdrawals, and ISAs.

1. Use the 25% Tax-Free Pension Lump Sum

One of the biggest tax benefits of pensions is that you can withdraw 25% of your pension pot tax-free.

  • You can take this as one lump sum or spread it over several years.

  • The remaining 75% of your pension is taxable as income.

Example: Using the 25% Tax-Free Allowance

If you have a £200,000 pension, you can take £50,000 tax-free. If you withdraw the remaining £150,000 in one go, you may pay higher-rate tax (40%) on some of it. Instead, spreading withdrawals over multiple years can reduce the tax bill.

2. Keep Total Income Below the Personal Allowance (£12,570)

You only pay income tax if your total taxable income exceeds the Personal Allowance, which is £12,570 per year (2023/24 tax year).

If you withdraw from your pension carefully, ensuring your total income stays below £12,570, you won’t pay any tax.

Example: Staying Within the Tax-Free Personal Allowance

  • State Pension income: £10,600 per year.

  • Pension drawdown: £1,970 per year.

  • Total taxable income: £12,570 → No tax due.

This approach works well for those with modest retirement expenses who don’t need large withdrawals.

3. Use ISA Savings for Tax-Free Income

Pension withdrawals are taxable (after the 25% tax-free amount), but ISA withdrawals are always tax-free.

  • Saving into an ISA before retirement allows you to supplement pension income without increasing your tax bill.

  • The ISA allowance is £20,000 per year, so using this alongside your pension can be a powerful strategy.

Example: Using an ISA to Avoid Pension Tax

  • Withdraw £12,570 from your pension (tax-free within the Personal Allowance).

  • Withdraw an extra £10,000 from an ISA (completely tax-free).

  • Total income = £22,570, but still no tax to pay.

4. Withdraw Smaller Pension Amounts to Stay in the Basic Rate Tax Band

If your total taxable income is below £50,270, you only pay 20% income tax. Any income above this is taxed at 40% or more.

To avoid paying higher tax rates:

  • Spread pension withdrawals over multiple years.

  • Avoid taking large lump sums that push you into the higher-rate tax bracket.

Example: Avoiding 40% Tax

If you take £60,000 in one year, you pay 40% tax on £9,730 (above the £50,270 limit).
Instead, withdrawing £45,000 per year keeps you in the 20% tax bracket.

5. Delay Your State Pension and Use Private Pensions First

If you don’t need your State Pension immediately, delaying it can:

  • Increase your payments when you do claim (by 1% for every 9 weeks you defer).

  • Reduce your taxable income now, helping to minimise pension withdrawals.

Using your private pension or ISAs first allows you to keep your overall taxable income lower in the early years of retirement.

6. Use Pension Drawdown Instead of a Lump Sum

Pension drawdown allows you to withdraw money gradually rather than taking a large lump sum.

  • Keeps your income within tax-free or lower-tax bands.

  • Allows your remaining pension to stay invested and growing tax-free.

  • Provides flexibility in how much tax you pay each year.

Example: Pension Drawdown Strategy

  • Year 1: Withdraw £12,570 (tax-free) + £10,000 from ISA (tax-free) → Total income: £22,570, no tax owed.

  • Year 2: Repeat the process, keeping withdrawals within tax-free or 20% tax bands.

7. Retire Abroad in a Low-Tax Country

If you plan to retire abroad, some countries have lower tax rates on pensions or even allow pension withdrawals tax-free.

  • Countries like Portugal (NHR scheme), Malta, and UAE offer tax advantages for pensioners.

  • Some countries do not tax foreign pension income, meaning you only pay UK tax on the first 25%.

If you are considering this, seek professional tax advice to understand how different tax treaties affect your pension withdrawals.

8. Use a Spouse’s Tax Allowance to Reduce Tax

If your spouse or partner has low or no income, you can:

  • Split pension withdrawals, keeping both of your incomes within the tax-free allowance (£12,570 per person).

  • Transfer ISA savings or investments into their name to make use of their tax-free income.

Example: Sharing Pension Withdrawals

  • You withdraw £12,570 (tax-free).

  • Your spouse withdraws £12,570 (tax-free).

  • Total household pension income: £25,140, with no tax owed.

Final Thoughts

While you can’t completely avoid tax on pension withdrawals, careful planning can minimise how much you pay.

  • Use your 25% tax-free allowance wisely.

  • Keep total income below £12,570 to pay zero tax.

  • Combine pensions and ISAs to withdraw tax-free income.

  • Avoid large withdrawals that push you into higher tax bands.

If you are unsure how to optimise pension withdrawals, consulting a financial adviser can help you develop a tax-efficient retirement strategy.