Can I cut the tax on my pension withdrawal?

23 January 2019


I’m coming up to 55 years old and plan on cashing in two of my pensions, which add up to £95,000. I know I can get 25% cash free but will pay a massive tax bill on the remainder. I do need all the money but don’t want to pay the tax bill. What are my options?



You don’t say whether you are currently working or not. If you are, then any withdrawal you make beyond the 25% tax-free cash will go straight on top of your earnings and this could push you into a higher income tax bracket. If you are able to put off taking taxable income, then it is worth considering.

If you do need money urgently, then you may pay less tax if you can take one pension as a lump sum in one year and the second the following year. If you plan to take both pensions as lump sums at the same time, then not only will you pay tax on the remaining 75%, but you are also likely to be overcharged by HMRC, which will levy an emergency tax charge. This overpayment can be reclaimed, but it is better to avoid paying it in the first place.

Take out lump sums over two years to cut the tax you’ll pay

There are other ways you can minimise your tax bill. For instance, you can take your withdrawals as a combination of tax-free cash and taxable income (as opposed to taking tax-free cash in one lump and then taking the taxable income later). By combining tax-free cash and taxable income in this way, less of the withdrawal will be subject to income tax so less could be paid out overall.

If you can spread these out over multiple tax years, this will also mitigate the amount of tax to be paid. There is also the added bonus of keeping more of your pension pot invested, with the potential to benefit from investment gains.

Tax on pension withdrawals

You can take up to 25% of your pension pot tax-free. Withdrawals after that are subject to income tax at your marginal rate [the highest rate of tax you pay] of either 20%, 40% or 45%. Your pension income will also be added to your total annual income, so could push you into a higher tax bracket.

Your tax-free amount can be taken as a single lump sum or you can take smaller regular sums, where 25% of each withdrawal is tax-free.

If your total annual income, including your pension, is under the personal allowance (£11,850), you won’t pay income tax on it.