Nine tax traps when you take money out of a pension

None of them is illegal, none of them is hidden, and every one of them catches sensible people.

The usual disclaimer

I am not a financial adviser. I am someone who built a calculator to check his own sums and kept going. This is my understanding of the rules as they stand for 2026/27, written so that people who know better can correct it. Tax rules change and your situation is your own.

Last week I listed every way you can take money out of a pension, and the comments taught me more than the writing did. The thing that kept coming up wasn't the routes. It was the traps beside them: the rules that turn a sensible withdrawal into a tax bill nobody planned for. So here they are, in one place.

Nothing on this list is a loophole or a trick. Each is a plain rule that behaves in a way most people don't expect the first time. And to keep it concrete, Sandra is back: 60, just retired, a £200,000 pension pot, a forgotten £8,000 pot from the nineties, no other income until her State Pension at 67. All figures use 2026/27 rates: £12,570 personal allowance, 20% to £50,270, 40% to £125,140, 45% above.

1. Emergency tax on the first withdrawal

The first time you take taxable money from a pension, your provider usually has no tax code for you, so HMRC's emergency code applies on a "month 1" basis. That means the payment is taxed as if you were going to take the same amount every month for a year. You get one twelfth of your allowances against it, and the rest climbs straight through the bands.

Sandra's version: she takes £30,000 in May as a single UFPLS payment. £7,500 is tax-free; £22,500 is taxable. The right tax, with no other income that year, is £1,986. The emergency code deducts about £8,556: a twelfth of the allowance at 0%, a twelfth of the basic band at 20%, a twelfth of the higher band at 40%, and the remaining £12,000-odd at 45%. She is about £6,570 out of pocket until she claims it back.

You do get it back: form P55 (or P53Z or P50Z depending on the circumstances) within about a month, or HMRC squares it at the year end. The trap is cash flow and shock, not permanent loss. The common avoidance is to take a small first withdrawal, say £100, so a proper tax code gets issued before the real money moves. Not every provider plays along, but it costs nothing to try.

2. The MPAA, the door that locks behind you

Take one pound of taxable income flexibly, whether UFPLS or income from a drawdown pot, and your annual allowance for pension contributions drops from £60,000 to £10,000, permanently. Tax-free cash on its own does not trigger it. Nor does a small pot lump sum, an annuity, or a defined benefit pension. Flexible taxable income does.

Sandra's version: suppose she hadn't quite retired, and £15,000 a year was still going into a workplace pension between her and her employer. The May UFPLS above drops her allowance to £10,000. The £5,000 over the line gets its tax relief clawed back through an annual allowance charge, every year it continues. The order matters: had she taken her tax-free cash only, or cashed the £8,000 small pot instead, nothing would have locked.

3. The £100,000 taper, and the last working year

Between £100,000 and £125,140 of income, the personal allowance is withdrawn at £1 for every £2, which makes the effective rate on that slice 60%. On its own, a pension withdrawal rarely puts a retired person there. Combined with a final year's salary, it does it all the time.

Not Sandra this time, but Mark: earning £90,000 and retiring in March, he takes a £40,000 UFPLS in his last working month to clear the mortgage. £30,000 of it is taxable, his income for the year becomes £120,000, and he loses £10,000 of personal allowance. Tax on the withdrawal: about £16,000. Had he waited five weeks into the new tax year, with no salary beside it: about £3,500.

4. The £268,275 cap on tax-free cash

The tax-free quarter of a pension is capped at £268,275 across your lifetime, and the cap is not indexed. A pot of £1.07m hits it. So does a smaller pot that grows for another fifteen years. Above the cap, every pound of growth inside the pension is taxable when it comes out, and that flips the usual advice about leaving the pension until last. A reader with thirty years in DC pensions put it better than I had: for people heading for the cap, take the tax-free cash as early as the rules allow and move it into ISAs at £20,000 a year, where the growth is never taxed. The £268,275 trap has the long version.

5. Your State Pension eats your allowance

The full new State Pension is £12,547.60 a year in 2026/27. The personal allowance is £12,570. That leaves £22 of allowance for everything else, so from State Pension age every pound of pension income is taxed from the first pound. One more triple lock rise and the State Pension itself becomes taxable, collected by adjusting the tax code on your other pension or by a bill at the year end.

Sandra's version: at 60 she can draw £12,570 of taxable pension income a year and pay nothing. At 67 the same £12,570 costs her about £2,510, because the State Pension has taken the allowance. The years before State Pension age are the cheap years to draw taxable pension money, which is exactly backwards from how most people feel about them.

6. Tax on your tax-free cash

The lump sum is tax-free once. What it earns afterwards is not. Interest above the personal savings allowance (£1,000 for a basic-rate taxpayer, £500 at higher rate, nothing at additional rate) is taxed as income. Dividends and gains outside an ISA are taxed too.

Sandra's version: she takes her full £50,000 tax-free cash and leaves it in a savings account at 4%. That's £2,000 of interest a year, £1,000 of it taxable: £200 a year in tax on money she was told was tax-free, rising with every rate rise. The fix is dull and effective: £20,000 a year into an ISA, and premium bonds for the rest while it waits.

7. The 2027 double tax on what you leave behind

From April 2027, unused pension pots are due to count as part of your estate for inheritance tax. If you die at 75 or over, whoever inherits the pot also pays income tax on it at their own rate as they draw it. Two taxes, same pounds.

Sandra's version, decades on: she dies at 82 with £300,000 still in the pension and an estate already over the nil-rate bands. Inheritance tax takes 40%: £120,000. Her daughter, a higher-rate taxpayer, draws the remaining £180,000 and pays 40% income tax: £72,000. £108,000 of £300,000 arrives. Money spent from the pension in Sandra's lifetime, or moved into an ISA, would have been taxed once.

This is the one that reverses old habits. For a lot of people the pension should now be drawn before the ISA, not after. The 2027 change, in full.

8. Tidying up the small pots

A personal pension worth £10,000 or less can be cashed in whole as a small pot lump sum, up to three times, without touching your £268,275 cap and without triggering the MPAA. It is one of the few genuinely generous rules left. And the most common way to lose it is to be organised.

Sandra's version: a helpful consolidation service sweeps her forgotten £8,000 pot into her main SIPP. It is now part of a £208,000 pot and the small pot route is gone. Cashed separately, it would have paid out £2,000 tax-free and £6,000 taxable at whatever her rate was that year, with no effect on anything else.

9. Frozen thresholds, the slow one

The personal allowance and the basic-rate threshold are frozen until April 2031 (the Autumn Budget 2025 added three more years to the freeze) and the higher-rate threshold with them. Your spending rises with inflation; the bands don't. A pension income that starts comfortably inside the basic band walks itself into the higher band over a decade without you changing a thing, and the after-tax value of a "level" income quietly falls even while the gross figure rises.

Sandra's version: she draws enough for £30,000 a year after tax and raises it with inflation. In year one that needs about £34,400 gross. If the bands stay where they are, the same real income costs more gross every year, and the tax on it grows faster than her spending does. The simulator has a switch for this ("maintain real take-home"), because when I first modelled my own plan without it, I had quietly given myself a pay cut every year for thirty years. It also follows the law past the freeze: thresholds rise with inflation from April 2031 by default, with "frozen throughout" kept as the pessimistic case, after a reader ran the same plan through his own model and mine and the frozen-forever assumption turned out to be worth £200,000 of lifetime tax on a 35-year plan.

What the simulator does about each

Emergency tax it ignores, deliberately, because it comes back. Everything else is in the maths: the MPAA is flagged when a flexible withdrawal happens while contributions continue; the £100,000 taper and the freeze to 2031 are in the tax calculation every year, with thresholds rising with inflation after that; the £268,275 cap is tracked against every tax-free slice; the State Pension takes the allowance from the year it starts; interest and gains on money outside an ISA are taxed; and the 2027 change is why "fill basic-rate band first" and "SIPP to ISA migration" exist as options. Small pots it leaves to you, because it cannot see that forgotten envelope.

What have I missed?

Nine traps, and I would be surprised if the list is complete. Scottish rates, protected tax-free cash, the annual allowance taper for very high earners and the lifetime allowance's ghosts are all real and all left out because they catch fewer people. If one of them caught you, or I have a number wrong, use the Contact button at the top of the page. Corrections go into this post with credit, as they did last time.

And if you want to see which of these your own plan walks into, year by year, that is what the simulator is for. Free, no login, nothing saved on our servers.