PTM024100 - General principles: overview of pensions taxation: the basics

As of 6 April 2024 there is no longer lifetime allowance. If you are looking for information about protections, enhancement factors and the lifetime allowance charge please see these pages on The National Archives. If you are looking for information about the principles of lifetime allowance and benefit crystallisation events please see these pages of The National Archives.

Glossary PTM000001
 

Pensions taxation lifecycle
Exempt, Exempt, Taxed
Tax reliefs and exemptions

Pensions taxation lifecycle

The taxation of registered pension schemes and their arrangements can broadly be divided into 3 stages:

  • contributions
  • investments
  • taking benefits.

Contributions

Payments are made into a fund by individual members and often by their employer too. Tax relief is available on those contributions giving an incentive to make adequate retirement provision for later in life.

See PTM024200 and PTM040000 for more information about contributions.

Investments

The fund into which the contributions are paid is invested with the aim of generating income and capital investment returns in order to provide retirement benefits at the relevant time. In money purchase arrangements the investment risk is borne entirely by individual members, whereas in defined benefit arrangements it is borne by the employer (and occasionally the member).

See PTM024400 and PTM120000 for more information about investments.

Taking benefits

At a future date, individuals will take benefits from the fund. Historically, benefits have often been taken as a tax-free lump sum (pension commencement lump sum) and regular income payments that are either paid by the scheme or through an annuity purchased from an insurance company.

From 6 April 2015 the way in which individuals can access their money purchase pension savings changed. Individuals now have greater flexibility with how they can take benefits (often referred to as ‘pensions flexibility’).

Individuals who have reached normal minimum pension age (currently age 55 but will increase to age 57 from 6 April 2028) can access as much of their pension savings in money purchase arrangements as and when they want. Individuals who choose this option will trigger the money purchase annual allowance rules. From that point onwards their pension savings in money purchase arrangements will be subject to a specific 'money purchase' annual allowance.

Broadly, benefits from a money purchase arrangement under a registered pension scheme can be taken from age 55 (age 57 from 6 April 2028) by choosing one or more of the following options:

  • taking a lifetime annuity
  • designating some or all of the money purchase funds to provide a drawdown pension
  • taking a scheme pension
  • taking an uncrystallised funds pension lump sum.

With the first 3 options the pension payments are taxable and the member can also choose to take a tax-free pension commencement lump sum when they first start their pension.

With the fourth option - the uncrystallised funds pension lump sum - part of the payment is tax-free and part is taxable as ‘pension income’. This reflects the fact that the member cannot be paid a pension commencement lump sum in connection with an uncrystallised funds pension lump sum.

Further information on how individuals may take their scheme benefits can be found at PTM060000.

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Exempt, Exempt, Taxed

The UK’s system of pensions tax relief is described as Exempt, Exempt, Taxed (E, E, T). There are 3 stages in the taxation of pension schemes: the first ‘E’ relates to the contributions stage, the second ‘E’ to the investments stage, and the ‘T’ to the taking benefits stage.

Exempt (E) - tax relief is available on individual and employer contributions to registered pension schemes. For individuals, tax relief on their contributions is available at their marginal rate and their employer’s contributions are not treated as a taxable benefit in kind. Therefore, employer contributions are not subject to income tax or corporation tax. There are limits to the amount of relief allowed.

Exempt (E) - most investment growth of the assets held within registered pension schemes is exempt from income and capital gains tax.

Taxed (T) - Most payments to scheme members are subject to income tax - see PTM024600. When a member starts taking their pension they can choose to be paid up to 25% of their pension pot as a tax-free pension commencement lump sum with the remainder as taxable pension. As an alternative, the member can be paid an uncrystallised funds pension lump sum, normally 25% of this is tax-free with the remainder subject to income tax.

Tax reliefs and exemptions

The following tax reliefs and exemptions are available in respect of registered pension schemes:

  • tax relief on member contributions - see PTM044000
  • tax relief on employer contributions - see PTM043000
  • tax relief on income and gains from most investments in the scheme - see PTM121000
  • certain lump sum benefit payments and lump sum death benefits are exempt from tax - see PTM060000 and PTM070000
  • contributions into and payments from a registered pension scheme are generally exempt from inheritance tax.