Sipp withdrawal guide 2025

Your Essential Guide: Understanding Tax on SIPP Withdrawals (Updated 2025)

Do you pay tax on SIPP withdrawals? This question matters more as you approach retirement age. The answer depends on how and when you access your pension funds.

SIPP tax rules require careful consideration for retirement planning. You can take up to 25% of your pension pot completely tax-free from age 55 (rising to 57 in 2028). A £100,000 SIPP allows you to withdraw £25,000 without paying any tax.

The remaining 75% faces income tax at your marginal rate. Your total income determines whether you pay basic rate (20%), higher rate (40%), or additional rate (45%) tax on SIPP income.

We will explain how the tax-free allowance works. You will understand what tax rates apply to the taxable portion. This guide provides practical strategies to reduce your tax liability when accessing your pension.

Planning for retirement or already drawing from your SIPP? This information helps you make tax-efficient decisions.

What part of your SIPP is tax-free?

SIPP withdrawals offer one major advantage. You can take part of your pension completely free of tax. Understanding exactly what portion is tax-free affects your retirement income significantly.

How the 25% tax-free cash works

You can take up to 25% of your SIPP as tax-free cash once you reach age 55 (rising to 57 from 2028). This tax-free amount is formally known as your Pension Commencement Lump Sum (PCLS).

There is an overall limit to consider. The maximum tax-free cash you can take across all your pension arrangements is currently £268,275. This limit applies regardless of how large your pension pot might be. Special protection arrangements with HMRC can change this rule.

You have flexibility in accessing this tax-free portion. You can take it all at once or as smaller withdrawals. A £400,000 pension pot allows you to take £100,000 tax-free and leave the remaining £300,000 invested.

Taking your tax-free cash involves setting up a drawdown arrangement. The remaining 75% of your pension stays invested until you decide to withdraw it as taxable income.

Can you take 25% every year?

The 25% tax-free allowance does not refresh annually. This is a common misconception. The 25% tax-free lump sum is a lifetime allowance, not an annual one. Once you have taken your full 25%, you cannot take any more tax-free cash from your pension.

You do not have to use your entire tax-free allowance at once. You can spread it out by moving portions of your pension into drawdown gradually. A £100,000 pension allows you to initially move £50,000 into drawdown, taking £12,500 tax-free. Later you can move another £50,000 to access the remaining £12,500 tax-free.

Using tax-free cash wisely

Before accessing your tax-free cash, consider how much you genuinely need. What do you plan to do with the remaining pension funds? The key is being mindful of how long your pension needs to last.

If you do not need the money immediately, you can leave it invested in your SIPP. It continues to grow tax-efficiently until you actually need it. This approach can potentially increase the overall value of your tax-free sum.

Consider combining your SIPP withdrawals with other tax-efficient investments such as ISAs. Stay within your personal allowance for income tax when planning future taxable withdrawals. This helps maximise tax efficiency.

What tax do you pay on the rest?

You need to understand how the remaining 75% will be taxed. After taking your tax-free cash, the rest of your pension becomes subject to income tax when you withdraw it.

SIPP tax rules for 2025

The rules for the 2025/26 tax year are straightforward. Money you withdraw beyond your tax-free entitlement is added to your other income and taxed at your marginal rate.

The key tax bands currently in effect are:

• Personal allowance: £12,570 – 0% tax
• Basic rate: £12,571 to £50,270 – 20% tax
• Higher rate: £50,271 to £125,140 – 40% tax
• Additional rate: Over £125,140 – 45% tax

There is a limit on tax-free benefits paid from pensions during your lifetime and on death. This is called the Lump Sum and Death Benefit Allowance, currently set at £1,073,100 for 2025/26.

How marginal tax rates apply

SIPP withdrawals are added to your other income sources for that tax year. Large withdrawals might push you into a higher tax bracket than expected.

State Pension or rental income already use part of your personal allowance. More of your SIPP withdrawal will be taxable. If you withdraw £20,000 from your SIPP while having £10,000 of taxable income elsewhere, your personal allowance covers £12,570. The remainder is taxed at 20%.

Tax is collected through PAYE. Your pension provider deducts tax before paying you. Your first withdrawal often uses an emergency tax code (1257L for 2025/26). This might result in overpayment.

Examples of taxable withdrawals

Consider Ann, who retired at 60 with a £450,000 SIPP and no other income. She could take drawdown income of £12,570 completely tax-free as it falls within her personal allowance.

Someone taking their entire £110,000 pension at once would receive £27,500 tax-free (25%). The remaining £82,500 would be taxable. A large portion would fall into the higher rate band. This results in £25,460 tax and a net payment of £84,540.

Do you pay tax on dividends or interest inside a SIPP?

Growth within your SIPP is completely tax-free. Dividends paid on investments held inside your SIPP are not subject to UK dividend tax. You pay no capital gains tax on investment profits. Interest earned on cash holdings is not taxable.

This differs from investments held outside tax wrappers. Dividend tax applies at 8.75% (basic rate), 33.75% (higher rate), or 39.35% (additional rate) on amounts exceeding the £500 dividend allowance.

This tax-efficient growth is one reason to keep your pension invested if you do not immediately need the income.

Reducing tax on SIPP withdrawals

Careful planning helps reduce the tax burden on your SIPP withdrawals. You can retain more of your pension savings throughout retirement. Understanding the tax implications of your withdrawals is crucial to maximizing your retirement funds. Many individuals make common mistakes in pension planning, such as failing to consider the timing of their withdrawals or not taking full advantage of tax allowances. By avoiding these pitfalls, you can enhance your financial security during retirement and ensure your savings last longer.

Timing withdrawals to stay in lower tax bands

Spreading withdrawals across multiple tax years often works better than taking large sums at once. Use your personal allowance (£12,570) each year since this doesn’t roll over.

Withdrawals might push you into higher tax brackets. Taking £50,000 in one year incurs much more tax than spreading the same amount across two or three tax years.

Taking money in early April gives you quicker access to any tax reclaims at the tax year’s end.

Using drawdown to control income

Flexible drawdown arrangements allow you to access funds as needed while keeping the remainder invested. This approach enables you to take smaller, regular amounts that keep you in lower tax brackets.

Withdraw just what you need rather than large lump sums. You can reduce your exposure to higher rates of tax.

Taking only tax-free portions first might seem appealing. Balancing taxable and tax-free withdrawals often produces better long-term results.

Emergency tax and reclaiming overpayments

Your first taxable SIPP withdrawal will likely be taxed using an emergency code, resulting in overpayment. HMRC assumes you’ll make identical withdrawals monthly for the rest of the tax year.

Consider making a small initial withdrawal (perhaps £100) to trigger HMRC to issue a correct tax code for future withdrawals.

If overpaid, complete one of these forms for refunds within 30 days:

• P55: For partial withdrawals without regular payments planned
• P53Z: For full pension withdrawals with other taxable income
• P50Z: For full pension withdrawals with no other income

SIPP withdrawals with other income sources

Your State Pension, rental income or part-time work all affect how much tax you pay on SIPP withdrawals. They use up part or all of your personal allowance.

From 2025, drawing taxable income from your pension triggers the Money Purchase Annual Allowance. This limits future pension contributions to £10,000 annually.

Coordinate your SIPP withdrawals with other income sources. This helps you maintain control of your overall tax position throughout retirement.

Special cases and future considerations

Certain special circumstances and future regulatory changes affect SIPP withdrawals beyond standard rules.

Early access due to illness or protected age

Severe health problems that prevent you from working may allow SIPP access before age 55 (57 from 2028). Professional sportspeople with agreements made before April 2006 typically have a protected pension age. They might qualify for early access.

Penalties for unauthorised withdrawals

Taking money from your SIPP outside permitted circumstances is costly. Unauthorised payment charges reach up to 55% on the entire withdrawal.

Withdrawing £20,000 early could result in an £11,000 penalty. You would receive just £9,000. The scheme faces additional charges of 15-40%.

Inheritance tax changes from 2027

April 2027 brings significant changes. Most unused pension funds will be included in your estate for inheritance tax purposes.

SIPPs currently remain outside your estate for IHT calculations. The government estimates about 10,500 estates will face new IHT liabilities. 38,500 will pay more inheritance tax, averaging £34,000 extra per estate.

What happens if you die before or after age 75?

Death before 75 means beneficiaries receive your SIPP tax-free. Funds must be designated within two years.

Death after 75 requires beneficiaries to pay tax at their marginal rate. Beneficiaries can pass remaining funds to their own successors if they don’t exhaust them.

Conclusion

SIPP withdrawal tax rules are essential knowledge for retirement income planning. The fundamental principles are straightforward. Your first 25% can be taken completely tax-free. The remaining 75% faces taxation at your marginal rate.

Strategic withdrawal planning makes a significant difference to your after-tax income. Spreading withdrawals across multiple tax years reduces your overall tax burden. Keep funds invested within your SIPP as long as possible. This takes advantage of the tax-free growth environment.

The inheritance tax changes from April 2027 require attention. Most unused pension funds will become subject to inheritance tax. This change affects thousands of estates. It emphasises the importance of estate planning alongside withdrawal strategies.

SIPP taxation offers flexibility with complexity. Understanding the rules helps you make better decisions about when and how much to withdraw. Tax rules become frameworks that help stretch your pension further throughout retirement.

Professional financial advice can help when planning SIPP withdrawals. Financial advisers can help you decide on the best withdrawal strategy. We will consider tax implications, timing, and your personal circumstances. This will help you make the right decisions about your retirement income.

Whether retirement lies years ahead or you have already begun withdrawals, regular reviews ensure you adapt to changing circumstances. We can help you build a withdrawal plan tailored to your needs. This gives you confidence about your financial future.

With our support, optimising your SIPP withdrawals is straightforward.

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