Pensions come with some of the most generous tax advantages available in the UK, but the rules are not always straightforward. Understanding the basics of how pension tax works can help you make better decisions about saving, withdrawing, and eventually passing on your pension. Here is a plain-English overview of where things stand.
Tax relief on contributions
Every time you contribute to a pension, the government effectively tops up what you put in through tax relief. The rate you receive depends on your income tax band.
Basic rate taxpayers receive 20% tax relief, higher rate taxpayers receive 40%, and additional rate taxpayers receive 45%. In practice this means a £100 pension contribution costs a basic rate taxpayer just £80 out of their own pocket, with the government contributing the rest.
The way this relief is applied depends on your pension scheme. Under a relief at source arrangement, you contribute from your take-home pay and your pension provider claims the basic rate relief from HMRC on your behalf. Higher and additional rate taxpayers need to claim any extra relief through self-assessment. Under a net pay arrangement, contributions are taken from your gross salary before tax is calculated, so you automatically receive relief at your full marginal rate.
The Annual Allowance
There is a limit on how much you can contribute to your pension and still benefit from tax relief each year. For most people in 2025/26 this is £60,000, or 100% of your earnings if lower. If you exceed this limit, you will face a tax charge on the excess, known as the Annual Allowance Charge.
It is worth knowing that if you have not used your full allowance in previous years, you may be able to carry it forward and contribute more in the current year, subject to conditions.
The Lifetime Allowance has been abolished
The Lifetime Allowance was abolished from April 2024, meaning there is no longer a cap on how much you can hold in your pension.
However, limits on tax-free cash remain. The Lump Sum Allowance limits the total amount of tax-free pension lump sums you can take across your lifetime, set at £268,275 for the 2025/26 tax year. The Lump Sum and Death Benefit Allowance, also set at £1,073,100, limits tax-free amounts on death. Any amounts above these limits are taxed at your marginal rate of income tax rather than being tax-free.
Taking money from your pension
You can currently access your pension from age 55, rising to 57 in 2028. There are several ways to draw your pension, each with different tax implications.
You can usually take up to 25% of your pension pot as a tax-free lump sum, subject to the Lump Sum Allowance described above. The remaining 75% is subject to income tax at your marginal rate when withdrawn.
If you opt for flexible drawdown, any withdrawals beyond the tax-free portion are taxed as income. If you purchase an annuity, the income it pays is also subject to income tax at your marginal rate, in the same way as any other earned income.
Passing on your pension
The rules around pensions and inheritance are changing significantly. Under current rules, if you die before age 75, pension benefits can be passed to beneficiaries free of income tax. If you die at age 75 or older, beneficiaries pay income tax at their own marginal rate on any income or lump sums they draw from the inherited pension.
However, it is important to be aware of a major upcoming change. From 6 April 2027, most pension death benefits and unused pension funds will be brought within the deceased’s estate for inheritance tax purposes, potentially taxed at 40% on any value above the available nil-rate bands. Transfers to a surviving spouse or civil partner will remain exempt. This is a significant shift that affects estate planning for many people and is well worth discussing with a financial adviser sooner rather than later.
The bottom line
Pension tax rules have changed considerably in recent years and are set to change further. Understanding the allowances that apply to you, how your contributions are treated, and what happens to your pension on death can make a real difference to your long-term financial position. A financial adviser can help you make the most of the tax advantages available and plan effectively for the years ahead.
A pension is a long-term investment. The fund value may fluctuate and can go down. Your eventual income may depend on the size of the fund at retirement, future interest rates, and tax legislation. Tax treatment depends on individual circumstances and may be subject to change.
Approved by In Partnership FRN 192638 June 2026
