Income drawdown and tax — what retirees often miss.
The 25% tax-free portion gets the headlines, but the other 75% is taxed as income — and the interaction with the state pension, emergency tax codes, and the higher-rate threshold catches many retirees off guard. Here's how drawdown taxation actually works.
- ▸25% of a pension pot can be taken tax-free (the pension commencement lump sum, or PCLS). The remaining 75% is taxed as income at the individual's marginal rate when withdrawn.
- ▸The state pension counts as taxable income and uses up part or all of the personal allowance — leaving less tax-free space for drawdown income.
- ▸First drawdown payments are often emergency-taxed (on a Month 1 basis), which can mean paying significantly more tax than owed. The excess is reclaimable.
- ▸Taking large drawdown amounts in a single tax year can push total income into the higher-rate band (40%) or even the additional rate (45%), when spreading over multiple years would keep it in the basic-rate band (20%).
The 25% tax-free portion
When entering drawdown, up to 25% of the pension pot can be taken as a tax-free lump sum — formally called the Pension Commencement Lump Sum (PCLS). This is capped at £268,275 (the lump sum allowance) for most people, which corresponds to a pot of approximately £1,073,100.
There are two ways to take the tax-free element:
Upfront. Take the full 25% as a lump sum when the pot enters drawdown. The remaining 75% is then "crystallised" and every subsequent withdrawal is fully taxable as income.
Incrementally. Some providers allow "phased drawdown," where each withdrawal is treated as 25% tax-free and 75% taxable. This spreads the tax-free element over time rather than taking it all at once.
The tax-free portion is genuinely tax-free — it does not count toward income for tax purposes and does not affect the personal allowance. But the remaining 75% is taxed at the individual's marginal rate, which depends on total income from all sources in that tax year.
The pension lump sum tax calculator shows the tax impact of different lump sum and withdrawal combinations.
State pension uses your personal allowance first
This is the point most retirees miss. The state pension is taxable income, but HMRC does not deduct tax from it at source. Instead, the tax is collected by adjusting the tax code on other income — including pension drawdown.
For 2026/27, the personal allowance is £12,570 and the full new state pension is approximately £11,973 per year. That means the state pension alone consumes almost the entire personal allowance, leaving only around £597 of tax-free headroom for drawdown income.
In practical terms: if a retiree takes £15,000 in drawdown income on top of the full state pension, almost the entire £15,000 (the taxable 75% portion — roughly £11,250) is taxed at the basic rate. Many retirees expect more of their drawdown to be tax-free because they are "only" taking £15,000, without realising the state pension has already used the allowance.
This interaction is even sharper for those with additional state pension or SERPS entitlements that push the state pension above the personal allowance, making every pound of drawdown income taxable from the first pound.
The income tax retirement calculator models the combined tax position across state pension and drawdown income.
Emergency tax on first withdrawals
When a pension provider makes the first drawdown payment, they often do not have the correct tax code from HMRC. In that case, they apply an emergency tax code — typically a "Month 1" or "Week 1" basis — which taxes the payment as though the individual will receive the same amount every month for the rest of the tax year.
A one-off withdrawal of £10,000 under Month 1 emergency tax is treated as if the annual income is £120,000 (£10,000 x 12). Tax is calculated on that hypothetical annual income, pushing a significant portion into the higher-rate band. The result: the retiree might pay £3,000–£4,000 in tax on a £10,000 withdrawal, when the correct tax (based on actual total income) might be £1,500–£2,000.
The excess is not lost — it is reclaimable. But the process takes time, and many retirees either do not realise they have overpaid or do not know how to reclaim.
How to reclaim emergency tax
HMRC provides three forms for reclaiming overpaid pension tax, depending on the situation:
- P55 — for partial withdrawals where you are leaving the rest of the pot invested
- P50Z — for when the pot has been fully withdrawn and you have no other income
- P53Z — for when the pot has been fully withdrawn and you do have other income
All three can be submitted online via the HMRC website or by post. HMRC typically processes repayments within 30 days if submitted online. Alternatively, waiting until the end of the tax year means the overpayment is automatically corrected through the annual tax reconciliation — but that can take up to 18 months.
The faster route is to contact HMRC (or ask the pension provider) to issue the correct tax code before the first withdrawal. Some providers will do this proactively; others require the retiree to arrange it.
Avoiding the higher rate band trap
The 2026/27 income tax bands for England, Wales, and Northern Ireland:
| Band | Taxable income | Rate |
|---|---|---|
| Personal allowance | £0 – £12,570 | 0% |
| Basic rate | £12,571 – £50,270 | 20% |
| Higher rate | £50,271 – £125,140 | 40% |
| Additional rate | Over £125,140 | 45% |
A retiree with a full state pension (£11,973) has approximately £38,300 of basic-rate space remaining before hitting the higher-rate threshold. If they take £50,000 in drawdown income in a single year (75% taxable = £37,500), they stay just inside the basic rate. Take £55,000, and the taxable portion (£41,250) pushes them over — with the excess taxed at 40%.
The trap is that large one-off withdrawals — to fund a home renovation, clear a mortgage, or gift to family — can easily breach the threshold. A £80,000 withdrawal (75% taxable = £60,000) on top of the state pension produces total taxable income of approximately £72,000. The £22,000 above the higher-rate threshold is taxed at 40% — an additional £4,400 in tax compared with spreading the same withdrawal over two tax years.
For very large withdrawals (above £125,140 total income), the personal allowance itself begins to be withdrawn — at a rate of £1 for every £2 of income above £100,000. This creates an effective marginal rate of 60% in the £100,000–£125,140 band.
The strategy implication is straightforward: where possible, spread withdrawals across tax years to stay within the basic-rate band. The income tax retirement calculator models the impact of different withdrawal amounts and timing.
- ▸The pension commencement lump sum (PCLS) — the 25% tax-free portion — is capped at £268,275 (the lump sum allowance) for most individuals, corresponding to a pot of approximately £1,073,100. [gov.uk]
- ▸The full new state pension for 2026/27 is approximately £11,973 per year, consuming nearly all of the £12,570 personal allowance and leaving minimal tax-free headroom for other income. [gov.uk]
- ▸HMRC overpayment reclaims via forms P55, P50Z, or P53Z are typically processed within 30 days if submitted online. [HMRC]
This is factual information, not financial advice. If you're unsure what's right for your situation, speak to an FCA-regulated financial adviser.