When investing in a SIPP you get tax relief. How much depends on whether you are a basic or higher rate tax payer. For this post, I am focussing on basic rate payer.

My understanding is that when you go to withdraw money from a SIPP when you hit (soon to be) 57 years old... you can withdraw 25% tax free, and the remaining 75% you need to pay tax on. For this reason, it's recommended to not withdraw in one lump sum because this may push you over the limit for a basic rate tax payer in the year you withdraw, which I understand.

What I need some clarity on is do you have to pay tax on the 75% of your pension pot, regardless of how many years you stagger the payments? Or is it 25% tax free each year?

If the former, this essentially means most of the tax relief given is undone. For a basic rate taxpayer the essential relief (in crude terms) would be... 0.2 * 0.75 = 0.15 = 15%. Meaning if you had a pension and withdrawed on the most favourable terms vs didn't have a pension and just paid 15% on income tax throughout your life you would be pretty much in a similar position financially?

I hope I'm mistaken on that because if tax obligation is 75% of the pot it seems to make SIPP pensions less appealing, as although you do get tax relief initially you eventually have to pay tax on most of your pension.

It seems investing in a LISA would be more strategically better because you get an additional 5% on top of the 20% relief, plus can withdraw the full amount once you reach 60 without having to pay any tax on it...

Am I misunderstanding anything here?


You can take 25% tax free total. Once that's taken, the rest is all taxed at the time you withdraw it. But if you stagger the payments you are likely to be able to stay under either the personal allowance, or the basic rate limit, limiting the amount of tax you have to pay.

As well as the 25% tax free amount, pensions are tax-efficient because they allow you to defer income to a point where you might expect to be earning less (or nothing) and therefore be in a lower tax band. So for example you might get tax relief at basic rate when putting the money in, but pay no tax because you're under the personal allowance when taking it out.

With a LISA you don't get any formal tax relief, but you do get the 25% government bonus which is pretty much the same as basic rate tax relief. I think for most basic rate tax payers, it makes sense to fill up the LISA before putting money in a SIPP.

  • Assuming you make a passive income and your Personal Allowance is already swallowed up during retirement - on your SIPP you will pay tax on 75% on your pension pot, including it's growth. That sucks. Especially as in 20/30+ years time income tax maybe higher than it is now. So compare that with an ISA you are locking in tax now, as oppose to deferring it for later. With pensions it's not liable for National Insurance contributions, so maybe with that factored in it's a bit more attractive. Overall as you say it seems LISA is a better option for basic rate tax payers.
    – Gary Green
    Dec 11 '21 at 17:23
  • 1
    @GaryGreen if you don't use a pension you'll pay tax on 100% of it! If you put the taxed money in an ISA then the growth is starting from a lower base, so it works out the same. As you say, future income tax rates are unknowable but they'd have to go up by more than 1/3 to cancel out the 25% tax-free element. Dec 11 '21 at 19:31

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