How UK income tax works
In brief: Your retirement income from pensions, investments, and the State Pension is all added together for income tax. The combined total determines which tax bands apply and how much you pay each year.
Income tax in the UK operates on a marginal band system. You do not pay a single rate on all your income. Instead, different portions of your income are taxed at different rates.
The bands
| Band | Income range | Tax rate |
|---|---|---|
| Personal Allowance | £0 – £12,570 | 0% |
| Basic rate | £12,571 – £50,270 | 20% |
| Higher rate | £50,271 – £125,140 | 40% |
| Additional rate | Above £125,140 | 45% |
These are marginal rates, meaning you only pay each rate on the income within that band. For example, someone with total income of £60,000 pays 0% on the first £12,570, 20% on the next £37,700 (up to £50,270), and 40% on the remaining £9,730.
All current tax thresholds are frozen until April 2031. Because income and pensions tend to grow with inflation while these thresholds stay the same, more income falls into higher bands over time. This effect is known as fiscal drag.
The Personal Allowance taper
The Personal Allowance is not available to everyone at its full level. For every £2 of income above £100,000, the allowance reduces by £1. At £125,140, the Personal Allowance is completely eliminated.
This creates an effective marginal tax rate of 60% on income between £100,000 and £125,140 — the standard 40% higher rate plus the loss of tax relief on the reduced allowance. This is the highest effective marginal rate in the UK income tax system.
Example: Someone with income of £110,000 has their Personal Allowance reduced by £5,000 (half the excess above £100,000), from £12,570 to £7,570. The additional tax from losing £5,000 of allowance is £2,000 (£5,000 at 40%), on top of the normal 40% rate on the income itself.
How pension income is taxed
Different pension types are taxed in different ways:
State Pension
The State Pension is taxable income. It is paid gross (without tax deducted), so the tax due is collected through other means — either by adjusting the tax code on other income, or through self-assessment. Because the State Pension uses up part of the Personal Allowance, other income sources may be taxed at a higher effective rate.
Drawdown income
Withdrawals from a crystallised drawdown pot are 100% taxable as income. The tax-free element was already taken at crystallisation. Drawdown income is added to all other income when calculating which tax band applies.
UFPLS withdrawals
Each UFPLS withdrawal is split: 25% is tax-free and 75% is taxed as income. The taxable portion is added to other income for the year.
Defined benefit pensions
DB pension income is taxed as employment income. Tax is usually deducted at source through the pension payroll, similar to how employment income is taxed via PAYE.
Annuity income
Annuity payments are taxed as income, typically with tax deducted at source.
Scottish income tax
Limitation: Most retirement modelling tools currently apply rest-of-UK (rUK) income tax bands only. Scottish taxpayers pay different rates (Starter, Basic, Intermediate, Higher, Advanced, and Top rate bands). If you are a Scottish taxpayer, your actual income tax will differ from projections based on rUK bands. Scottish rate support may vary by tool.
Why this matters for your retirement
In retirement, your income typically comes from multiple sources — State Pension, private pensions, investment income, and potentially rental income. All of these are added together to determine your total tax bill.
Retirement projections model the tax on each income source year by year, under the withdrawal assumptions you specify. The projected tax in each year reflects the combination of income sources active under your stated inputs.
These projections are for modelling purposes only. They do not constitute financial advice. Tax rules are subject to change. Please consult a qualified financial adviser before making financial decisions.