Tax When You Retire: A First-Year Checklist for New Pensioners

When you retire, your income stays taxable but the mechanics change: National Insurance stops on your earnings once you reach State Pension age, your State Pension is paid without any tax taken off, and your Personal Allowance of £12,570 usually gets attached to one private pension through your tax code. The two things that catch new pensioners out are emergency tax on the first drawdown payment and taking too much taxable income in a single tax year.

Work through the checklist below in your first year. Most of it is a one-off tidy-up, and the tax code part is worth checking twice.

Key points

• Pension income — State Pension, annuities, drawdown — never attracts National Insurance, at any age.
• The State Pension is paid gross, so tax on it is collected by reducing the code on your other pension.
• A first flexible withdrawal is often taxed on a month 1 emergency code, which can over-deduct thousands of pounds.
• Splitting a large withdrawal across two tax years can use two Personal Allowances and two basic-rate bands.
• Scottish taxpayers pay Scottish rates on pension income, with the 42% band starting at £43,662.

What changes on day one

Three things happen at once when the salary stops and the pensions start.

Your income becomes a stack of smaller payments. Instead of one payroll, you may have a State Pension, one or more workplace pensions, a drawdown pot, savings interest and perhaps some dividends. Each source is taxed under its own rules, but they are added together to work out which band you fall into.

Your employer's payroll no longer handles anything. You will get a P45 from your last employer. Keep it — a pension provider may ask for it, and it is how HMRC works out whether you have overpaid for the part-year you worked.

Your marginal rate probably drops. If you were a higher-rate taxpayer on £60,000 and retire on £28,000 of pension income, you move from 40% to 20%. That matters for decisions such as whether to make a final pension contribution while still working, and for whether savings interest is covered by the £1,000 Personal Savings Allowance (basic rate) or only £500 (higher rate).

Checklist: the admin

• Tell HMRC you have retired and give them the start dates and amounts of each pension.
• Check your State Pension award letter against your State Pension forecast.
• Check each new tax code when the first payslip-style pension statement arrives.
• If you are married or in a civil partnership and one of you now has income under £12,570, look at whether the Marriage Allowance transfer of £1,260 is available — it is worth up to £252 a year and can be backdated four years.

National Insurance stops — mostly

National Insurance is a tax on earnings, not on pensions. You pay no NI on your State Pension, on an annuity, or on anything you take out of a pension pot, whatever your age.

If you carry on working past State Pension age, employee Class 1 NI stops from the date you reach it — you keep paying income tax, but the 8% band between £12,570 and £50,270 and the 2% above it no longer apply to you. Give your employer proof of age so the payroll switches to the correct NI category letter. Your employer still pays secondary Class 1 at 15% above the £5,000 secondary threshold; that cost does not come out of your pay.

If you are self-employed, Class 2 stops from State Pension age. Class 4 at 6% and 2% is charged for the whole of the tax year in which you reach State Pension age, and only drops away for tax years that begin after you reach it.

One thing worth doing before you reach State Pension age: if your record has gaps that would cut your pension below the 35 qualifying years needed for the full £241.30 a week, voluntary Class 3 contributions cost £18.40 a week.

Tax codes on pensions: where the errors live

The State Pension is always paid without deduction of tax, but it is taxable. HMRC's fix is to reduce the tax code on your largest private pension so that the tax on both is collected from one place.

Take someone in England with the full new State Pension and a £10,000 workplace pension. Fifty-two weeks at £241.30 is £12,547.60 a year, which uses up almost all of the £12,570 Personal Allowance. HMRC issues a code of roughly 2L on the workplace pension, so almost the whole £10,000 is taxed at 20%:

All of that £1,995 comes out of the £10,000 pension, so it pays about £667 a month gross and £500 net. That is correct, but it surprises people who assumed the deduction would be spread.

Second and third pensions

Only one pension can carry the Personal Allowance. Others normally get a BR code (everything at 20%) or a D0 code (everything at 40%). If a small second pension is sitting on BR while you actually have allowance to spare, you are overpaying month by month. Check your codes on the GOV.UK tax code service and ask for a reallocation if the split is wrong.

The first flexible withdrawal

When you take money flexibly from a pot for the first time, the provider usually has no code from HMRC and must use an emergency code on a month 1 basis. That treats the single payment as if it were one twelfth of your annual income, so a one-off withdrawal is taxed as though you earn twelve times as much.

A £30,000 taxable withdrawal taxed on a 1257L month 1 basis loses roughly £11,900 in tax on the spot. If that withdrawal is your only income for the year, the real liability is £30,000 − £12,570 = £17,430 at 20%, or £3,486 — an overpayment of about £8,400.

You get it back either automatically at the end of the tax year, or sooner by claiming in-year: form P55 if you have taken a flexible payment and not emptied the pot, P50Z if you have emptied it and have no other taxable income, or P53Z if you have emptied it and do have other income.

Timing withdrawals across tax years

This is where the largest sums are won or lost. Taxable income is assessed tax year by tax year, so two years of withdrawals means two Personal Allowances and two basic-rate bands.

Compare taking £70,000 of taxable pension income in one tax year with splitting it as £35,000 across two, for someone in England, Wales or Northern Ireland with no other income:

The split saves £6,460, simply by keeping every pound inside the basic-rate band. In Scotland the same comparison is £17,382 against £9,002 — a saving of about £8,380 — because the 42% higher rate bites from £43,662 of income rather than £50,270. Use the pension drawdown calculator to model the split before you request anything.

Other timing points

• Up to 25% of a pension can normally be taken tax free, subject to an overall lump sum allowance of £268,275. Tax-free cash is not income, so it does not use your Personal Allowance or push you into a higher band.
• A large taxable withdrawal that lifts total income above £100,000 starts to taper the Personal Allowance away, creating an effective rate far above 40% on the slice concerned.
• Taking anything beyond tax-free cash flexibly cuts your annual allowance for future pension saving from £60,000 to the £10,000 money purchase annual allowance. If you plan to keep contributing, that order matters.

State Pension, allowances and the rest of your income

Your allowances do not change because you have retired — there is no higher age allowance any more. What changes is which allowances are actually useful.

• Personal Allowance £12,570. Frozen, and the full new State Pension of £12,547.60 a year now absorbs virtually all of it.
• Personal Savings Allowance. £1,000 of interest tax free at basic rate, £500 at higher rate, nil at additional rate. Run the numbers with the savings interest tax calculator if you have moved a lump sum into deposit accounts.
• Starting rate for savings. Up to £5,000 of interest can be taxed at 0% where your non-savings income is low — genuinely useful in a gap year between stopping work and the State Pension starting.
• Dividend allowance £500, then 10.75% at basic rate, 35.75% at higher and 39.35% at additional.
• Capital gains. The annual exempt amount is £3,000, with rates of 18% and 24% on most assets.
• Blind Person's Allowance £3,070 is on top of the Personal Allowance and transferable to a spouse.

Scottish taxpayers pay Scottish rates — 19%, 20%, 21%, 42%, 45% and 48% — on pension income, but savings interest and dividends are always taxed at the UK rates wherever you live.

Finally, expect a letter rather than a tax return. Many pensioners with straightforward income are dealt with by Simple Assessment: HMRC works out the tax from the figures it holds and asks you to pay, with no Self Assessment registration needed. Check it rather than assuming it is right, particularly in the year your State Pension starts, because part-year amounts are a common source of error.

What to do next

Map your expected income sources for the whole tax year first, then work out the tax, then decide how much to draw. The retirement calculator shows what your combined pensions leave you with after tax, and the pension drawdown calculator lets you test a single large withdrawal against a phased one. If you also want to see how a final contribution before retiring affects a higher-rate bill, the pension tax relief calculator covers that.