How to avoid paying tax on pension drawdown

At Regulated Advice, we have booked over 9,000 appointments with financial advisors since 2013, and how to avoid paying tax on pension drawdown is the single most common enquiry we receive. Knowing how to avoid paying tax on pension drawdown means understanding the taxation rules before you crystallise the scheme.

Pension drawdown lets you take money from your pension pot while the rest stays invested. However, most withdrawals count as taxable income, so timing and planning matter more than people expect.

How common is drawdown compared with an annuity

According to the FCA, there were 349,992 income drawdown plans taken out in 2024/25 compared with 88,430 annuity plans in the same year. This is a split of roughly 80% to 20%, or about four to one in favour of drawdown.

Annuity rates were virtually rock bottom in the years before pension freedoms arrived in 2015, since interest rates themselves were near zero and made annuity contracts very poor value. Rates have crept up since, but remain low by historic standards, which is a large part of why drawdown continues to dominate.

This lines up with what advisors hear directly from clients. Many people booking an initial appointment want to see every option laid out, but have often already leaned toward drawdown before the conversation even starts, largely because an annuity is harder to get out of once bought.

There is no firm data on how many actually convert to drawdown after advice, but the preference is a common one to hear at the enquiry stage.

Use your tax-free lump sum wisely

You can usually take 25% of your pension pot tax-free, up to a lifetime limit. This is often the simplest way to reduce tax on pension drawdown.

Instead of taking it all at once, you can take smaller tax-free chunks alongside taxable income, which helps you stay in a lower tax band each year.

Stay within your personal allowance

Everyone gets a personal allowance before income tax applies, currently £12,570. This is almost identical to the full new state pension, which is £12,547.60 a year, so someone relying on the state pension alone pays little or no tax on it.

If your only income is from drawdown, keeping annual withdrawals close to the personal allowance means little or no tax is paid. This works best for those with several income sources, since each can be timed to fill the allowance without spilling into a higher band.

Between the personal allowance and £50,270 in England, Wales and Northern Ireland, income is taxed at 20%. In practice, this means most people who keep their total income below £50,270 will pay tax at the basic 20% rate, which is the reality for the majority of retirees drawing an income.

Spread withdrawals across tax years

Taking a large lump sum in one year can push you into a higher tax bracket. Instead, spreading withdrawals over several tax years often keeps you in the basic rate band, taxed at 20% in England, Wales and Northern Ireland, which reduces your overall tax bill.

This is one of the most effective ways to reduce tax on pension drawdown for those without an urgent need for cash.

Consider your other income alongside drawdown

If you are still working, receiving rental income, or drawing a state pension, this all counts toward your total taxable income. Therefore, drawdown withdrawals should be planned around what you already receive, not in isolation.

An advisor can model this to find the most efficient approach for tax, and you can find a financial advisor through Regulated Advice to talk through your own situation.

Use ISAs alongside your pension

Money withdrawn from a pension and placed into an ISA grows and is later withdrawn tax-free. As a result, some people take a modest income from their pension each year that is efficient for tax, and top up an ISA, giving them a second pot to draw from without extra tax.

Watch out for the money purchase annual allowance

Once you start taking taxable income from drawdown, your annual pension contribution allowance drops significantly, to £10,000 under current rules. Consequently, anyone still working and contributing to a pension should check this before withdrawing, since it can limit future tax relief.

Get advice before you start

Tax rules around pension drawdown change often, and everyone's situation is different. A regulated financial advisor can build a withdrawal strategy around your income, allowances, and goals, so you take money out in the most efficient way for tax. You can find a financial advisor through Regulated Advice to get started.