There are two active choices you can make with your pension pot. You can take money out of it or move it somewhere else. The two sound similar, but the tax treatment is very different.
When you draw money out, up to 25% is tax-free, capped at £268,275, and the rest is taxed as income. When you move a pension between registered schemes, nothing is taxed at all, because a transfer is not a withdrawal. Get either action wrong, though, and the cost is steep, up to 55% on money you only ever meant to move or draw.
If you are approaching retirement or weighing up whether to consolidate or move a pension, this article walks through what is taxed, what is not, and where the real risk sits. It does not address defined benefit transfer suitability, which is regulated financial advice, or what happens to a pension on death, as those are separate subjects.
Key Takeaways
How UK Pensions Work: A Quick Overview
A pension is a pot of money you build up for later life, held under a scheme registered with HMRC. You pay in over your working years, usually with your employer adding to it too, and the money is invested so the pot grows. Contributions attract tax relief, which is much of the point of using one.
Most pensions today are defined contribution: the pot is simply what has been paid in plus growth. Older workplace and public sector schemes are often defined benefit, promising a set income for life instead of a pot you own.
You can normally start taking money from age 55, rising to 57 from 6 April 2028. Take money out before then, without a protected pension age or ill health, and it counts as an unauthorised payment charged at up to 55%.
How Much Can You Contribute Tax-Free to a Pension Scheme?
The maximum you can pay into a pension with tax relief each year depends on your earnings and your available annual allowance. Here is how it works:
- Your Earnings - Relief is capped at the higher of £3,600 gross or 100% of your relevant UK earnings. This covers employment income and profits from a trade or profession, so the self-employed are covered by their trading profit. Rental income does not count, so a landlord with only property income gets relief on £3,600 gross a year, whatever the pot is worth.
- The Annual Allowance - £60,000 for 2026/27, across all your pensions. You can add any unused allowance from the previous three tax years, provided you were a member of a registered pension scheme in each of those years. Pay in above the allowance and the excess carries a tax charge.
The taper is where higher earners get caught. Once your threshold income goes over £200,000 and your adjusted income over £260,000, the £60,000 allowance starts to shrink. For every £2 of adjusted income above £260,000 you lose £1 of allowance, until it bottoms out at £10,000 once adjusted income hits £360,000.
Case in point: Aisha, a Landlord With a Day Job
Aisha earns £190,000 from her job and makes £110,000 in rental profit. She pays £60,000 into her pension, the full annual allowance for 2026/27, expecting relief on all of it.
Her salary alone would sit under the taper. The rental profit is what tips her over.
Adjusted income = £190,000 plus £110,000 = £300,000.
That is £40,000 above the £260,000 line. Her allowance falls by £1 for every £2 over, so £40,000 halved is a £20,000 cut.
Available allowance = £60,000 less £20,000 = £40,000.
Only £40,000 of her £60,000 now attracts relief. The other £20,000 sits above the allowance and is taxed at her marginal rate of 45%.
The Two Things You Can Do With Your Pension Pot
Every pension decision comes down to two moves with completely different tax rules. The difference comes down to one detail: whose bank account the money lands in.
- Drawing Your Pension (Taking Money Out) - Money moves from your pot to your personal bank account. Because you are receiving a benefit, HMRC steps in, allowing up to 25% tax-free, while the remaining 75% is taxed as income. If you do not take it all at once, the untaken part usually stays invested in ‘drawdown.’ This simply means it stays in the market, and you take income from it as and when you choose.
- Transferring Your Pension (Relocating the Pot) - Money moves directly from one registered provider to another (subject to certain conditions discussed below). You never touch cash, no taxable benefit is triggered, and the entire transfer remains tax-free.
Treating a transfer like a withdrawal, or accidentally taking control of the cash midway, is one of the fastest ways to trigger an unexpected tax bill.
Pension Withdrawals
Taking money out is where most people start, and where the tax bill is easiest to reduce with a little planning. The headline rule is simple: a slice is tax free, the rest is taxed as income. The detail is where value is won or lost.
When Can You Withdraw From Your Pension?
There is no upper age limit. You can leave a pension untouched well past state pension age, which can be a useful planning tool in its own right.
How Much Can You Take Tax Free?
Up to 25% of your pot, capped at the lump sum allowance of £268,275. This tax-free element is called a pension commencement lump sum, and 25% is broadly the maximum, measured against the value coming into payment (PTM063210).
Once you have used up your lump sum allowance across all your pensions, any further lump sum stops being tax-free and is taxed as income instead. For most people, the 25% figure is what matters, but anyone with larger pots needs to track the £268,275 cap carefully.
Is A Pension Withdrawal Taxed?
Yes. Everything beyond the tax-free element is taxed as pension income at your marginal rate, collected through PAYE. If you take an Uncrystallised Funds Pension Lump Sum (UFPLS), 25% is tax free and the remaining 75% is taxable in the same way.
The trap here is bunching. A large withdrawal in a single tax year can push you into the higher or additional rate or start stripping away your personal allowance once total income passes £100,000. The size of the withdrawal is a choice, and so, largely, is the rate you pay on it.
Why Your First Withdrawal is Often Overtaxed
HMRC almost always applies an emergency tax code to your first flexible payment. With no full year code to work from, your provider taxes that one- off amount as though you will draw the same sum every month for the rest of the year. A single large withdrawal is therefore taxed far too heavily at source, often at the higher rate on money that should sit within the basic rate band.
None of it is lost. You have three ways to recover the overpayment:
- Wait for HMRC to reconcile your position after the tax year ends
- Pick it up through self assessment, if you file a return
- Reclaim it directly using form P55, where you have taken only part of your pot (claim back tax on a flexibly accessed pension overpayment).
The first two work but mean waiting, often the best part of a year. The P55 route is far quicker, with HMRC usually settling within weeks. Different forms apply if you have emptied the pot, depending on whether you have other taxable income.
Client Example: The Emergency Code Bill
Raymond, 61, took a £20,000 taxable withdrawal in May to help with a house move. His provider applied an emergency code and taxed it as though he would draw £20,000 every month, tipping the notional income into the higher rate and leaving him with far less than he had budgeted for.
Rather than wait until the following spring, he filed a P55 and had the overpaid tax refunded within a few weeks, in good time for the move.
How To Save Tax On A Pension Withdrawal
The tax you pay on a withdrawal is largely within your control if you plan the timing. The most effective steps are usually the simplest:
- Spread Withdrawals Across Tax Years - Every tax year brings a fresh personal allowance and a fresh basic rate band. Splitting a large withdrawal across two or more years keeps more of it taxed at 20% rather than 40%, and is often the single biggest saving available.
- Use Your Full Personal Allowance Every Year - You can draw £12,570 of taxable pension income a year with no tax at all, before any other income. In the years before the state pension starts, that allowance often goes unused, so drawing up to it each year is close to free money. Combined with the 25% tax-free element, the effect can be striking.
One client, retired at 60 with no other income before state pension age, drew around £15,000 from her pot each year as an uncrystallised funds pension lump sum. A quarter of each withdrawal was tax-free, and the taxable three quarters sat entirely within her personal allowance. She took money out year after year without paying a penny of income tax.
- Draw From Both Partners' Pensions - A couple has two personal allowances and two basic rate bands between them. Where both hold pensions, taking income from each rather than emptying one can roughly double the amount drawn before higher rate tax applies. Steering withdrawals towards the lower earner is often worthwhile.
- Take Your Tax-Free Cash in Stages - Instead of taking your whole 25% tax-free lump sum at once, you can draw it in slices over several years. Each slice is part tax-free, and part taxable. This lets you control how much taxable income lands in any tax year, rather than crystallising whole pot and taking a large taxable hit in a single year.
- Keep Total Income Below the Key Thresholds - Two lines in the tax system do real damage if you cross them. Income above £50,270 is taxed at 40% rather than 20%, so a withdrawal that tips you over is taxed at double the rate on the excess. The second is harsher. Once income passes £100,000, your personal allowance falls by £1 for every £2 above it, which creates an effective 60% rate on income between £100,000 and £125,140. Keeping a withdrawal just below either line can save far more than the sum involved.
- Use Small Pots to Protect Your Annual Allowance - A "small pot" is a whole pension worth £10,000 or less that you cash in as a single lump sum. As with any withdrawal, a quarter is tax free and the rest is taxed as income. The advantage is what it avoids. Normally, once you start taking taxable money flexibly from a pension, the amount you can still pay into pensions each year and get tax relief drops sharply, from £60,000 down to £10,000. Cashing in a small pot does not trigger that cut, so if you are still working and building up a pension, you can take the money without harming what you put in later (PTM063700).
- Draw on Other Savings First - Money already outside a pension, such as ISAs or cash, can usually be spent with no further tax. Using those first, and leaving the pension invested, keeps your taxable income low in the early years and lets the pot carry on growing until you actually need it.
Client Example: Funding a Goal Without a 40% Bill
Gordon, 61, was still working part-time on around £30,000 a year and wanted £40,000 from his pension to help his daughter with a house deposit.
His first instinct was to take the whole £40,000 in one go. Because his salary already used most of his basic rate band, a large part of that withdrawal would have been taxed at 40%, and his provider's emergency code would have taken even more up front.
We planned it differently. He took his 25% tax free cash, £10,000, as a single payment, which came out with no tax at all. The remaining £30,000 he drew as income, £15,000 before the tax year ended and £15,000 shortly after the new one began. Split that way, his total income stayed inside the basic rate band in both years, so the taxable part was charged at 20% throughout and none of it reached the higher rate.
The first income payment was still caught by an emergency code, so he reclaimed the overpayment with a P55 and had it back within weeks. He got his daughter her deposit and kept almost £2,000 that a single rushed withdrawal would have handed to HMRC.
Pension Transfers
People move a pension for many reasons: advice from a financial adviser, better returns or lower charges elsewhere, or simply to bring several old pots into one. Done well, and in the right order, a transfer costs nothing in tax.
Done carelessly, it is one of the costliest mistakes in the pension system, and it goes wrong in two different ways.
The first is letting the money be paid to you instead of moving it scheme to scheme. Once you are over 55, that usually counts as a withdrawal rather than a transfer, so a quarter is tax free and the rest is taxed as income at your marginal rate, up to 45%. You also lose the tax shelter on the whole pot.
The second is a genuine unauthorised payment, taxed at up to 55%, triggered by moving only part of a pension already in payment, or by moving the money into something that is not a registered scheme, which is how many pension scams work. Accessing before 55 does the same.
Is a Pension Transfer Taxed?
The transfer itself is not taxed, as long as it is a recognised transfer paid directly between UK registered pension schemes. Moving a pot is not a withdrawal, so no 25% tax free lump sum arises and no income tax is due at the point of transfer. The pot crosses at its full value (PTM100010).
A transfer does not make the money tax free, though. It moves the pot, it does not change the tax on what is inside it. Every taxable pound is still charged as pension income when you draw it from the new scheme, exactly as it would have been from the old one. If you are already taking your pension, that income stays taxable before and after the move.
So the tax question on a transfer is really whether the money stays inside the pension system at all. Let it be paid out to you and it is taxed now, as Daniel found.
When a Transfer Became a Taxable Withdrawal
Daniel, 60, was still working and paying in, had never touched his pension, and wanted to move a large pot to a scheme with lower charges. A direct transfer, scheme-to-scheme, would have cost him nothing.
Instead, the money was paid out to his own bank account, which made it a withdrawal rather than a transfer. A quarter came out tax-free, but the rest was charged as pension income, and because the pot was large, the top of it was taxed at his 45% marginal rate. What he treated as a simple transfer cost him tens of thousands.What Counts As a Recognised Pension Transfer?
A recognised transfer is a payment made directly from one registered pension scheme to another, or to a qualifying recognised overseas scheme, with the funds held to provide your benefits (section 169 Finance Act 2004). The direct, scheme to scheme route is the whole point, because it is what keeps the movement outside the tax charges that apply to money paid to you.
The single biggest error is letting the funds pass through your own hands, even briefly. The moment the money lands in your personal account it stops being a recognised transfer and becomes an unauthorised payment, taxed at 40%, with a further 15% surcharge where the amount is large enough. That is up to 55% of your pension gone, on money you only ever meant to move (PTM134100).
Peter Browne v HMRC
In this First tier Tribunal case, a taxpayer set out to move two pension funds into a self invested pension. He received cheques for the funds but, with the new scheme paperwork not ready, paid them into his own bank account in the meantime.
He was then dismissed by his employer, and it took three years to finish the transfer. The Tribunal held that the cheques were unauthorised payments the moment they reached his account, because a recognised transfer allows no halfway stage where the money is held by anyone other than a registered scheme.
The 40% charge stood. Only the surcharge was quashed, because he had always intended to move the funds to a new scheme.
Can You Transfer Only Part of Your Pension?
Yes, if the pot is uncrystallised. Where the scheme rules allow, you can transfer part of your uncrystallised rights and leave the rest where it is, and it remains a recognised transfer (PTM100010).
This is widely misunderstood, often the wrong way round. Many people believe a partial transfer is never allowed, when in fact it is perfectly acceptable for an untouched pot, subject to your scheme permitting it.
The £1,000 That Cost Him £10,000
A client asked us to review a £19,000 transfer he had already made from one UK pension to another. On the face of it, it looked clean. He was 57 and entitled to access the pension; both schemes were UK-registered, and the money had moved straight from one to the other without ever passing through his hands.
Every obvious condition for a recognised transfer was met, and he expected no tax at all. Then one fact surfaced that changed the answer. He had taken money out of that pension in an earlier year, so it was already a pension in payment, not an untouched pot.
A pension in payment has to be transferred as a whole. He had left £1,000 behind in the old scheme, which turned the £19,000 he moved into a partial transfer of a pension in payment, and so into an unauthorised payment. As it was almost his entire pot, it drew the 40% charge and the 15% surcharge, more than £10,000 on a transfer he had assumed was routine.Can You Transfer a Pension You Are Already Drawing From?
Yes, but it has to move as a whole. A pension already in payment can be transferred, and that includes money you have moved into drawdown, but the transfer must cover the whole of that pension. Move only part of a pension in payment and the amount you shift is not a transfer at all in HMRC's eyes, it is an unauthorised payment, taxed at up to 55%.
So the rule flips with the state of the pot. Untouched rights can be split and transferred in part. A pension in payment, or one already in drawdown, must move in full or not at all. Knowing which of the two you hold before you give any instruction is what keeps you clear of the most common charge in this area.
Can I Transfer My UK Pension to an Overseas Scheme?
Moving a UK pension abroad brings an extra risk: the overseas transfer charge of 25% of the amount moved. It applies to transfers to a qualifying recognised overseas pension scheme unless an exclusion is met, for example, where you live in the same country as the receiving scheme (PTM102200).
Two points catch people out. First, you must give the scheme the required information before the transfer, or the charge applies by default. Second, even where an exclusion applies, the charge can still bite on any amount above your overseas transfer allowance, which mirrors the lump sum and death benefit allowance of £1,073,100. An overseas move needs checking against these rules before anything is instructed.
How to Save Tax on a Pension Transfer
Keeping a transfer free of charge is mostly about discipline and sequence. The points that matter most are these.
- Always Move the Money Scheme-to-Scheme - A recognised transfer is paid straight from one registered scheme to the next, and the funds never reach you. Accept a cheque or let the money land in your own account even for a day, and the whole amount becomes an unauthorised payment taxed at up to 55%. It is the most expensive mistake in this area and the easiest to avoid.
- Match the Split to the State of the Pot - An untouched pot can be transferred in part or in full. A pension you have already started to draw, including anything in drawdown, must move as a whole. So, before you instruct anything, be clear which type each pot is. It is the state of the pension, not the size of the transfer, that decides whether a charge arises. Leaving even a small amount behind in a pension that is in payment is enough to trigger the charge.
- Check Any Protection Before You Move - If you hold a protected pension age or protected tax-free cash rights, a transfer can strip them away unless it is done by the right route. That loss can cost far more than the move was ever going to save, so confirm the position before you act, not after.
- Handle an Overseas Move with Care - A transfer to an overseas scheme can carry a 25% charge. Confirm whether an exclusion applies, and give your scheme the information it asks for before the transfer, so the charge does not fall due by default.
- Do Not Let a Transfer Drift - Once a transfer starts, see it through promptly. Delays, mislaid paperwork, or funds parked anywhere other than a pension scheme are exactly how a routine move turns into a charge.
Consolidating Three Pensions Cleanly
A client, 58, wanted to bring three pensions together into one scheme to make them easier to manage. Two were untouched. The third he had moved into drawdown a few years earlier.
His plan was to transfer all three the same way, leaving a small balance in the drawdown pot so it stayed open. That one step would have been costly. A partial transfer of a pension in payment is an unauthorised payment, so moving almost all of the drawdown pot while leaving a sliver behind would have drawn the 40% charge and the surcharge.
We sequenced it instead. The two untouched pots went straight across, the drawdown pot moved in full rather than in part, and every payment ran directly scheme to scheme. All three pensions ended up in one place with no tax charge at all.What is Pension Recycling
Your tax-free lump sum has already benefited from tax relief once, when it was paid into the pension. If you could take that cash out tax-free and simply pay it straight back in, you'd get a second helping of tax relief on the same money — the government topping it up again for no new saving at all.
That is what "recycling" means, and it's why HMRC steps in. Where the rule's conditions are met, the lump sum is treated as an unauthorised payment for tax purposes, so the same up to 55% charge applies to money you thought was tax-free (PTM133810).
The rule only bites where all of these are present:
- You receive a tax free lump sum.
- Your pension contributions become significantly higher because of it.
- The recycling was planned in advance.
- The lump sum, with any others in the previous 12 months, exceeds £7,500.
- The extra contributions add up to more than 30% of the lump sum.
Ordinary retirement saving is not caught. Increasing contributions from salary or savings, or paying more simply to build a bigger pot, is fine. What HMRC targets is a deliberate loop that manufactures tax relief out of tax free cash.
How Malcolm turned tax free cash into a tax bill
Malcolm, 60, took a £30,000 tax free lump sum from his pension. He had always meant to put most of it straight back in to pick up tax relief a second time, and that same year he paid £25,000 back into his pension.
That plan walked into every part of the recycling rule. The lump sum was well over the £7,500 limit, his contributions jumped far above their usual level purely because of the cash, the extra was more than 30% of the lump sum, and it had been planned in advance. With all of the conditions met, HMRC treated the whole £30,000 as an unauthorised payment, taxing his tax free cash at up to 55% and wiping out the relief he had been chasing.
What would have kept him clear was patience rather than a different sum. Building his contributions up gradually out of income, instead of routing the lump sum back in as a planned one- off, would have fallen outside the rule entirely.
Moving Versus Drawing: A Quick Decision Check
The two actions pull in opposite directions on tax, so it pays to be clear which you are doing before you act. In short:
Conclusion
The decision line is straightforward once you hold it clearly: know whether you are drawing or moving, and whether the pot is untouched or already in payment, before you do anything. Almost every serious pension tax charge comes from confusing those two things.
Get it wrong and the cost is real, up to 55% of money you only ever meant to move or take. Get it right and most of these charges never arise at all.
If you are about to move or draw on a pension, take advice on the exact position of your pot first. A short conversation beforehand is far cheaper than an unauthorised payment charge afterwards.
Frequently Asked Questions (FAQs)
Normally 25% of the pot, capped at the lump sum allowance of £268,275 across all your pensions. Anything above the tax-free element is taxed as pension income at your marginal rate. Once the £268,275 cap is used, further lump sums are taxed as income too.
The transfer itself is not taxed if it is a recognised transfer paid directly between registered schemes. It does not make the money tax free, though: the pot is still taxed as income when you later draw it. Funds reaching your own account are taxed at up to 55%.
HMRC applies an emergency tax code to your first flexible payment, taxing it as if you will draw that sum every month. Reclaim it with form P55 if you took only part of the pot, or P50Z or P53Z if you emptied it.
Yes, if the pot is untouched, or uncrystallised. A pension already in payment, including funds in drawdown, must be transferred in full. Moving only part of a pension in payment is an unauthorised payment, taxed at up to 55%.
Normally from age 55, rising to 57 on 6 April 2028, with no upper age limit. Taking benefits earlier, without a protected pension age or qualifying ill health, is treated as an unauthorised payment charged at up to 55%.
WORK WITH UK PROPERTY ACCOUNTANTS
Moving or drawing from your pension can have significant tax consequences. At UKPA, we help you understand the tax impact, review your options, and plan withdrawals efficiently to avoid unnecessary tax charges.
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