Annuity Taxation Basics

When you take money out of your pension pot only twenty-five percent of what you take out will be tax-free. So, what happens with the remaining seventy-five percent? Unfortunately, each time you touch your pension pot you can expect to pay income tax on seventy-five percent of it. The twenty-five percent that isn’t taxed doesn’t affect your personal allowance, which is the income amount you have to pay taxes on. The high annuity taxation cost is one reason people are looking for alternatives to a basic annuity, such as an ISA. However, if you’re not familiar with how annuities work in general, or you don’t know much regarding the taxation process, you’ll find that an annuity can still be a great solution for you and your family when you need it the most.

To learn more about ISAs and find out whether or not they’re the right investment option for you, click here.

Taxation Deductions

The amount of taxation you can expect on your pension pot will depend on your tax rate and your total income for the year.

There are a couple of options you can choose from when you take your tax-free amount. You can take it all out at once or you can take the twenty-five percent as a lump sum, without having to pay taxes. In order to do this, you can leave the remaining seventy-five percent untouched. You must either take the whole pot as cash, get an adjustable income or purchase a guaranteed income annuity.

You can also take out smaller sums of cash from your pension without paying tax since twenty-five percent of each chunk will be tax-free.

The money you take out of your pension will come from the provider and will already have the tax deducted. Any taxes dues on state pensions will also be deducted.

Taxation Explained

You’ll pay taxes if your total annual income amount is more than your personal allowance. Total income will include the amount of state pension you receive, private pensions,  earnings from self-employment or unemployment, and any taxable benefits you receive.

You may also be required to pay a higher income tax should you take a larger amount from your private pension. At the end of the tax year, you may also owe extra tax.

If your private pension is more than one million pounds then you’ll usually have to pay a tax charge. The taxes will already be deducted by the pension provider before you receive your payment.


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If your annual income is less than your personal allowance then you won’t have to pay any taxes.

As we mentioned earlier, if you take out a lump sum from your pension pot, twenty-five percent of the money will not be taxed and it won’t count against your personal allowance for the year.

The Importance of Monitoring Pension Funds

Every year make sure that the right amount of taxes have been deducted for each of your pension pot payments. This is especially important if you have another source of income.

If your pension was taxed more than it should have been then you’ll be able to reclaim the difference. Additionally, you will also have to pay taxes if you notice that your pension was taxed incorrectly and you underpaid.

Inheriting a Pension

If someone inherits your pension, taxes will also be deducted for both private and state pensions.

If you are the one to inherit pension funds when the pension pot holder dies, if they were under the age of seventy-five, any amount of income taken from their pension fund will be tax-free. Should you decide to purchase an annuity with the remaining funds in the pension pot, then the annuity that’s paid to you will also be tax-free.

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If the pension pot beneficiary was over the age of seventy-five a the time of death, then any remaining pension funds can be taken out as a lump sum or used as income at the marginal rate of income tax.

Planning for the Future

Before you sign up for an annuity and make plans for your retirement, it’s important that you’re aware of the fact that you’ll have to pay tax on your income. Knowing more about annuity taxation will help you budget for the future, especially when it comes to setting retirement goals.

Final Thoughts

Annuity taxation is one thing most people aren’t aware of when they purchase an annuity. But regardless of what provider you go through, the same taxation fees will apply. If you’d like to learn more about annuities, and how you and your family can benefit from regular income you can count on, meet with a local annuity provider who can discuss taxation laws, annuity options, and the type of fees you can expect to pay when you touch your pension pot.

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