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Pay Less Tax on Your Pension: What Every Retiree Should Know
Ruby Layram
2nd May 2025
If you’re nearing retirement or already enjoying life after work, chances are you’ve got a few questions about how best to access your pension. And more to the point: how to avoid paying more tax than necessary.
Let’s face it, after spending decades building your retirement savings, the last thing you want is for the taxman to take a bigger bite than he should. But the reality is that many retirees in the UK trigger tax traps without even realising it — and one of the biggest culprits is something called the Money Purchase Annual Allowance (or MPAA).
In this guide, we’ll walk you through the practical steps you can take to reduce tax on your pension drawdown.
What Is Pension Drawdown?
Drawdown is one of the most flexible ways to take money from your pension. Rather than buying an annuity (which pays a guaranteed income for life), you keep your money invested and withdraw what you need, when you need it.
You can usually start drawdown from age 55 (rising to 57 from 2028), and you get to take 25% of your pot tax-free. The rest is taxable income, just like your salary was before you retired.
Sounds simple enough, right? Not so fast.
The Hidden Trap: The Money Purchase Annual Allowance (MPAA)
Here’s where things can go a bit pear-shaped.
If you start taking income from your pension in certain ways, you could unintentionally trigger the MPAA. This restricts the amount you can pay back into your pension each year and still get tax relief.
Normally, most people can contribute up to £60,000 a year into their pension (or 100% of their earnings, whichever is lower). But once the MPAA is triggered, that allowance drops to just £4,000 a year. Forever.
Why Does That Matter?
Well, lots of people want to keep working part-time after 55. Or maybe you take a sabbatical, dip into your pension to cover costs, then go back to work and resume contributing.
But if you’ve triggered the MPAA, you’ll be severely limited in what you can pay back in — and therefore, how much tax relief you can earn going forward.
That could cost you thousands in lost tax savings over time!
How Do You Accidentally Trigger the MPAA?
Here are the most common ways people fall into the MPAA trap:
- Taking a taxable income from a flexi-access drawdown pot.
- Withdrawing an Uncrystallised Funds Pension Lump Sum (UFPLS).
- Taking more than the maximum from a capped drawdown pension.
- Receiving income from a flexible annuity.
- Converting a capped drawdown plan to flexi-access.
Even if these terms sound like gibberish (don’t worry, you’re not alone), the key message is this: the moment you take anything more than your 25% tax-free lump sum, you could trigger the MPAA.
How to Avoid the MPAA Trap
Here are some practical ways to avoid triggering the MPAA too soon:
1. Stick to Your 25% Tax-Free Lump Sum
If you need to access some cash, you can normally take up to 25% of your total pension pot without triggering the MPAA.
For example, from a £200,000 pot, you could take £50,000 tax-free and still keep your full annual allowance intact.
2. Use Small Pot Lump Sums (Under £10,000)
You can take up to three personal pension pots valued at less than £10,000 each without triggering the MPAA. This can be a smart move if you have old, small pensions dotted around.
3. Consider Phased Retirement
Instead of taking a big lump sum or drawing income all at once, take a more gradual approach.
Use your tax-free lump sum over time, and delay accessing the taxable portion until you’re ready to retire fully.
4. Blend Annuity and Drawdown
Combining the certainty of an annuity with the flexibility of drawdown (aka a “blended solution”) can help you control your tax exposure.
Annuities provide guaranteed income, which is taxed, but they don’t trigger the MPAA.
Meanwhile, you can keep the rest of your pension invested for growth.
Using Income Tax Bands to Your Advantage
Once you do start drawing taxable income from your pension, be smart about how much you take and when. The UK has different tax bands:
- 0%: On the first £12,570 (your personal allowance)
- 20%: On income between £12,571 and £50,270
- 40%: On income between £50,271 and £125,140
- 45%: On income over £125,140
Plan your withdrawals to stay within lower tax bands wherever possible. For example, if you have other income (like rental property or part-time work), factor that into your total income for the year.
You could also split your withdrawals over multiple tax years to avoid bumping into a higher rate band.
Don’t Forget About Your Spouse
Married or in a civil partnership? Great news, you may be able to share the tax load!
Each person has their own personal allowance, so if your partner is in a lower tax band, consider splitting income or using their pension to withdraw money more tax-efficiently.
Also, pensions don’t typically form part of your estate for inheritance tax (IHT) purposes. So, keeping money in your pension, rather than drawing it down unnecessarily, can also help reduce the eventual IHT bill for your family.
It is worth noting here that as of April 2027, pensions will no longer be exempt from inheritance tax.
Think Twice Before Consolidating Pensions
It often makes sense to consolidate multiple pensions to reduce fees and simplify your finances.
But be careful, some older pensions come with valuable guarantees (like a higher tax-free lump sum entitlement or annuity rates). Transferring these could mean losing those benefits.
Before consolidating, always double-check what you’re giving up.
Time It Right
Timing your withdrawals can make a big difference. For example:
- Wait until the new tax year to access funds if it helps you stay in a lower tax band.
- If your income will drop significantly in the future (e.g. when you stop working), delay drawing taxable income until then.
Also, remember that you don’t have to touch your pension at all if you don’t need to. Your pot can stay invested and grow tax-free until you’re ready.
Get Professional Advice
We know we sound like a broken record here, but it really is worth speaking to a qualified financial adviser before making any big pension decisions.
The cost of advice is often dwarfed by the potential tax savings and peace of mind you get in return.
Next Steps
If this article has inspired you to doo some pension admin, here are a few smart moves that you could take to reduce tax on your drawdown.
- Review your pension pots and check what type each one is.
- Plan your withdrawals to stay within the tax bands that suit your situation.
- Use your tax-free lump sum wisely. You don’t take more than you need.
- Avoid triggering the MPAA unless you’re sure you won’t need to contribute to your pension again.
- Speak to a financial planner to tailor the right strategy for you.
Your pension is one of the most powerful financial tools you have in retirement. Used wisely, it can provide the income and flexibility you need, without handing over more than necessary to HMRC.
A little planning now can save you a lot later!
So before you draw down your pension, take a step back, make a plan, and make sure you’re getting the best out of what you’ve saved so hard for.
Still got questions? Talk to a regulated adviser or visit a service like Pension Potential to compare options and map out your next move.
Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence. When investing your capital is at risk.
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