Comparing UK Income Tax Liabilities for Different Pension Structures

Tax and pensions are two of the most complex factors for any individual planning to retire, access their lifetime savings, move abroad to another country, or make informed decisions about the best way to manage their retirement assets.

One of the common misconceptions is that income tax is only payable against regular pension benefits since pension freedoms mean that most pension lump sum drawdowns, up to 25%, are tax-free. However, this may not be the case, because tax allowances, reliefs and exemptions are not universal, and there are multiple caveats to be aware of.

For example, although the standard 25% tax-free lump sum drawdown assumption is correct, this only applies to lump sums up to £268,275, and anything above that value will potentially be taxable.

Pension Payments and Transactions That Attract UK Income Tax Obligations

There are multiple aspects of pension contributions and drawdowns that can give rise to a tax liability. This may, though, depend on the type of pension scheme you have, your age at the point you access your pension, and other circumstances such as your country of residence and taxpayer jurisdiction.

Examples include:

• Making contributions to your pension fund
• Transferring a fund to a different scheme or investment structure
• Drawing a lump sum from your pension wealth
• Arranging periodic pension benefit payments
• Leaving pension assets to an inheritor

UK pension funds may be subject to the Lump Sum Allowance (LSA), currently set at the £268,275 limit we mentioned above, the Lump Sum and Death Benefit Allowance (LSDBA), and the Overseas Transfer Allowance (OTA).

Both of the latter allowances are fixed at £1.073 million, the same cap as the old Lifetime Allowance (LTA). The LSDBA limits the total tax-free lump sums you can draw from your pension throughout your lifetime and on your death, which means any remaining tax-free lump sums can be distributed to your beneficiaries when you pass away.

The OTA comes into force if you decide to transfer a UK-based pension fund overseas. It sets a maximum pension value that you can transfer without attracting a tax liability. Pension transfers exceeding that threshold are subject to the Overseas Transfer Charge (OTC), which is levied at a rate of 25%.

The takeaway is that UK income tax doesn’t solely apply to the benefits you extract from your pension but can be a significant financial aspect of every part of your pension and retirement planning.

Different Pension Tax Relief Systems for Workplace Funds

Pension tax reliefs can apply differently for employees making contributions to their workplace fund, depending on how the provider or employer manages the scheme. There are two potential ways to benefit from tax relief:

• The ‘gross tax’ basis means your contributions are deducted from your pay before taxation, providing full tax relief by excluding pension deposits from income tax.
• The ‘net tax’ basis involves contributing pension funds after taxation, where the pension fund then claims the tax relief on your behalf, usually adding 20% (based on the basic rate) to your pension fund.

While both options seem to have the same financial outcome, higher-rate taxpayers may need to claim tax relief for the balance, assuming the tax relief repaid on a net tax basis pension fund remains at 20%, to avoid unnecessarily paying further income tax of up to 25%.

Income Taxes Payable on Pension Contributions

Tax relief is available against UK pension contributions up to £60,000, or up to 100% of the individual’s earnings, if this is lower. This becomes more complicated for pension savers with higher annual incomes above a threshold of £200,000, or with adjusted earnings of £260,000 or more, which includes figures such as employer pension contributions.

In these instances, and for pension savers who have previously drawn on their pension funds, the annual allowance is reduced on a tapered system by £1 for every £2 earned above the limit. However, a minimum allowance of £10,000 is available to all taxpayers for the current tax year.

Therefore, higher earners who wish to make more substantial contributions to their pension schemes must understand how those deposits will be taxed – or excluded from pension reliefs.

Paying Income Tax on Pension Withdrawals

All UK taxpayers receive an annual personal allowance, set at £12,570, although this amount can change for those with incomes above £100,000 or for those claiming allowances such as the Marriage Allowance.

In effect, that means any pension income received, whether from the State Pension, a private scheme or a workplace fund, is subject to income tax at your marginal tax rate, based on the current tax brackets of:

• 20% tax on income from £12,571 to £50,270
• 40% tax on income from £50,271 to £125,140
• 45% tax on income of over £125,140

The government has confirmed that it intends to keep these bands frozen until April 2028. We have previously published an article exploring How UK Tax Band Freezes Impact Expat Wealth and, indeed, exposure for any taxpayer with a British-based pension fund or income.

Additionally, lump sum withdrawals may be taxable, depending on the protections built into your pension product and other features that safeguard your right to access a larger proportion of your fund without a tax penalty. Otherwise, the lump sum tax-free limit remains at 25% of the previous LTA.

Pension Tax Liabilities for Varied Funds

Added to these many considerations, much may depend on the type of fund you have – that could be one of the following or several:

• The UK State Pension, or a workplace defined benefit or defined contribution scheme.
• An overseas pension fund, such as a Recognised Overseas Pension Scheme (ROPS).
• A private pension scheme, like a Self-Invested Personal Pension (SIPP).
• An older pension fund pre-dating the 2015 Pension Freedoms Act.

In every case, it is essential to understand what tax liabilities will arise, when, and on which transactions, contributions, or drawdowns, to ensure your retirement savings are not unnecessarily eroded.

For further advice and a personalised analysis of your pension finances, retirement wealth, and likely future tax obligations, please contact Chase Buchanan Private Wealth Management to arrange a convenient time to talk.

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Chase Buchanan Insurance Services, Agents & Advisors is authorised and regulated by the Cyprus Insurance Companies Control Service with License No 6883 and offers services in the EU on a cross-border basis as per the provisions of the Insurance Distribution Directive (IDD).

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*Information correct as at October 2025