Frozen allowances, rising withdrawals: why more retirees may pay more tax

For many people approaching or in retirement, the focus is rightly on how best to use their pension savings to fund the lifestyle they want. But data from the Financial Conduct Authority (FCA)1 shows a clear trend: withdrawals from pensions are rising sharply. When combined with the government’s decision to freeze tax allowances until 2028, this creates a problem that many retirees are only just beginning to feel: more of their income is being dragged into higher-rate tax.

¹Financial Conduct Authority: retirement income market data 2024/25

When reading this article, please bear in mind that tax treatment depends on your circumstances and is subject to change.

What the data tells us

• Over 960,000 pension plans were accessed for the first time in 2024/25 — an 8.6% increase on the previous year
• Withdrawals jumped by over a third, from £52.2bn to £70.9bn
• Only 30.6% of people took advice when first accessing their pension

In simple terms, more people are drawing more money from their pensions and often doing so without professional advice.

The frozen allowance effect

Ordinarily, tax thresholds rise gradually with inflation, helping to keep people in the same tax band year after year. But with allowances frozen until 2028, this natural adjustment isn’t happening. That means:

• The personal allowance (the amount you can earn tax-free) remains at £12,570
• The basic-rate band still ends at £50,270
• Any income above that is taxed at 40%, and income over £125,140 at 45%

With inflation driving up wages and the State Pension, and private pension withdrawals on the rise, more people are being pulled into higher bands without realising it. This is known as fiscal drag.

Why pension withdrawals are affected

Pension withdrawals are treated as income. Withdrawing too much in a single year can easily push someone over the £50,270 threshold.

Let’s look at an example:

1. John earns £20,000 from part-time work.
2. He takes a £30,000 pension withdrawal.
3. £7,500 is tax-free (25%).
4. £22,500 is taxable income.
5. Combined with his salary, John now has £42,500 taxable income. Still within basic rate.

But if John had withdrawn £50,000, then £37,500 would be taxable, pushing his total income to £57,500. That means over £7,000 falls into the 40% band.

Frozen thresholds mean this bracket creep will happen more and more frequently, even for modest withdrawals.

The double hit: inflation and tax

The FCA’s data shows retirees are already withdrawing more, with the total value of pension withdrawals rising by almost £19bn in a single year. Some of this is likely down to higher living costs. Inflation has eroded the value of money, so people need to take out more just to cover the same expenses.

But when higher withdrawals meet frozen tax bands, the result is clear: more tax is paid, leaving less for retirement.

Who is most at risk?

1. Those in their 50s and early 60s who are still working and accessing pensions. Extra income can easily push them into higher bands.
2. Basic-rate taxpayers with larger pots. Withdrawing lump sums or taking high drawdown rates risks tipping income into 40% tax unnecessarily.
3. Higher earners approaching retirement. Already close to the £50,270 threshold, they have little room before crossing into the next band.
4. Those without advice. The FCA data shows nearly 70% of people accessed pensions without advice, increasing the likelihood of inefficient withdrawals.

What can you do?

The good news is that careful planning can make a big difference. Some strategies include:

• Stagger withdrawals: rather than taking large one-off amounts, spread withdrawals over multiple tax years to keep income in lower bands
• Blend income sources: use ISAs, savings, or part-time earnings alongside pensions to balance taxable and tax-free income
• Review tax allowances: married couples may be able to share income between them to reduce overall tax
• Consider annuities: for some, locking in a guaranteed income can reduce uncertainty while protecting against underestimating how long you will live for

The value of advice

The FCA’s review underlines that many people are making big financial decisions alone. Taking regulated advice should mean:

• Withdrawals are planned in a tax-efficient way
• Your income strategy is sustainable and aligned with your lifestyle goals
• Potential withdrawal pitfalls are properly managed
• Peace of mind that you have a long-term plan and someone to monitor it with you

The tax savings from advice could more than cover its cost, while the peace of mind can be invaluable.

The bottom line

Retirement planning doesn’t stop once you’ve built your pension pot; how you access it matters just as much. With allowances frozen and withdrawals rising, more retirees are being pulled into higher-rate tax without even realising it.

By planning ahead, and by taking advice, you can make sure more of your money stays where it belongs, funding the retirement you’ve worked hard for.

Paul Dunne
CEO
Chartered Financial Planner and Fellow of the Personal Finance Society

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This article is for information only and is not a personal recommendation. If you are considering changes to your pension, you should seek regulated financial advice.