Pension withdrawals: how taking money out is taxed

Money leaves a money-purchase pension under one tax principle: normally 25% is tax-free and the balance is taxable pension income, charged at the member’s marginal rate under ITEPA 2003 s.579A and collected through PAYE (PTM063300). The routes out — an uncrystallised funds pension lump sum (UFPLS), tax-free cash followed by flexi-access drawdown, or a small-pots payment — differ in when each element arrives, not in that principle. What separates a clean withdrawal from an expensive one is three side effects: the emergency tax code on the first payment, the £10,000 money purchase annual allowance, and the recycling rule on the tax-free cash.

The routes out, and how each is taxed

An UFPLS (FA 2004 Sch 29 para 12A) carries the split inside each payment: 25% is paid tax-free — capped at the member’s available lump sum allowance — and 75% is taxed as pension income in the same way as any pension from a registered scheme (PTM063300). Take £40,000 as an UFPLS and £10,000 arrives free of tax while £30,000 joins the year’s taxable income. The UFPLS calculator splits a given payment and tests the allowances.

PCLS plus flexi-access drawdown takes the tax-free element up front: a pension commencement lump sum, tax-free up to the permitted maximum — broadly 25% of the value crystallised, capped at the remaining lump sum allowance (PTM063210 / PTM063230) — with the balance designated into drawdown. Nothing else is taxed at designation; every later income payment from the drawdown fund is then taxable in full, with no second tax-free slice. The income side is worked in tax on pension drawdown income; the lump-sum side in tax on a pension lump sum.

In passing: a pot worth up to £10,000 can be extinguished in one go as a small-pots lump sum. The same 25%/75% split applies, but a small-pots payment is not a trigger for the money purchase annual allowance and does not consume the lump sum allowance; a member can take up to three from personal pensions (PTM063700).

PTM063200 / PTM063210 / PTM063300 / PTM063700 ; FA 2004 Sch 29 ; ITEPA 2003 s.579A (Part 9).

Where the taxable element sits in the computation

The taxable element is non-savings pension income. It stacks at the bottom of the income computation (ITA 2007 s.16): it consumes the personal allowance first, fills the basic rate band (£37,700 for 2026/27), then the higher and additional bands — and it pushes any savings or dividend income up into higher bands rather than sitting above them. Because the whole taxable element also counts in adjusted net income, a large withdrawal can carry the member over £100,000 and strip the personal allowance at £1 for every £2 above that threshold (ITA 2007 s.35).

That interaction is where withdrawals get expensive. Take the corpus case: a £40,000 UFPLS on top of £90,000 of other income.

£12,000 of that is simply 40% on the slice. The other £4,000 is 40% on the £10,000 of personal allowance the slice strips away by lifting adjusted net income from £90,000 to £120,000. The same £30,000 slice costs £6,000 on £20,000 of other income and £12,000 on £60,000 — the withdrawal is taxed at whatever marginal position it lands in. The pension withdrawal tax calculator computes the attributable tax for any mix of withdrawal and other income.

ITA 2007 s.16 and s.35 ; PTM063300 ; Appendix C of the engine corpus (ADR-047).

The first payment is over-taxed: the month-1 emergency code

On the first flexible payment the scheme usually holds no current tax code for the member’s pension income, so HMRC has it operate the 1257L emergency code on a week-1/month-1 basis (PAYE manual PAYE94055). Month-1 means the payment is taxed as though it were one month of an annual income: only one-twelfth of the personal allowance and of each rate band is set against it. A one-off withdrawal is therefore heavily over-taxed at source.

Nearly three and a half times the true tax leaves the payment at source. The over-deduction is not lost — it comes back through form P55 (pot not emptied), P53Z (pot emptied, other taxable income) or P50Z (pot emptied, no other income), or through year-end reconciliation — but it is a cash-flow fact worth pricing before the payment is requested. The pension emergency tax calculator shows the month-1 deduction, the true liability and the form the member’s circumstances point to.

HMRC PAYE94055 ; gov.uk forms P55 / P53Z / P50Z ; ADR-049 (EMTAX-EX-01).

Taking taxable income switches on the MPAA

The first taxable flexible payment — an UFPLS, or any income from flexi-access drawdown — is a trigger event for the money purchase annual allowance: from that point on, money-purchase pension saving above £10,000 a year is chargeable (PTM056500). A PCLS taken alone, with no drawdown income, is not a trigger; nor is a small-pots payment. Carry-forward survives the trigger but can never be added to the £10,000 money-purchase cap. Whether a given payment trips it is worked in does a UFPLS trigger the MPAA; the allowance itself is in the money purchase annual allowance.

Two rules on the tax-free 25%

The tax-free side has a lifetime ceiling: the lump sum allowance, £268,275 as standard (PTM171000; FA 2024 Sch 9). Every PCLS, and the tax-free element of every UFPLS, consumes it; once it is used, further “tax-free” cash is taxed at the member’s marginal rate instead. The detail, including the protected higher figures, is in the Lump Sum Allowance, explained.

And the tax-free cash cannot simply be rerouted back into a pension. Where tax-free cash of more than £7,500 is taken within a rolling twelve months and, as part of a pre-planned arrangement, contributions rise by more than 30% of it, the recycling rule makes the whole lump sum an unauthorised payment, charged at 40% (FA 2004 Sch 29 para 3A; PTM133800). The six conditions, the £7,500 and 30% gates, and the worked charges are in the pension recycling rules.

PTM171000 ; PTM133800 ; FA 2004 Sch 29 para 3A ; FA 2024 Sch 9.

Working a real withdrawal? Each calculator above produces a branded compliance-annex PDF with the full working and the PTM references. For planning and illustration only; this guide does not constitute financial or tax advice.