Optimising Your State Pension for Tax Efficiency

The State Pension may not be your biggest retirement pot – but it might just be the most valuable. It comes with a government guarantee, and it will rise every year by at least 2.5%. You should make sure you qualify for the full amount and also be clear about how it affects your tax position. 

Why your state pension is worth more than you think 

For people with large, diversified portfolios, the state pension might appear as the runt of the litter.  

From the age of 66 (rising to 67 from May 2026) you can claim £230.25 a week. Times that by 52 and you get to an annual income of £11,973. 

But it’s not the scale of the income that’s significant. It’s the fact that it’s guaranteed.  

Not many things in your later life will come with such a copper-bottomed guarantee. You may be one of the last of the few to have a defined benefit pension, which also pays a pre-determined income.  But these pensions are disappearing fast, shrinking by 3% each year. For many, the State Pension may soon be the only guaranteed income stream left. 

Moreover, the State Pension rises each year, thanks to the ‘triple lock’ calculation, based on the highest of consumer prices, earnings growth or an arbitrary 2.5%.  

The other thing is that you can optimise the State Pension, so that you receive the most available, without dialling up your tax liability. 

What you can earn tax free – in total 

Let’s start with the tax basics and then move onto the detail.  

Everyone has a personal allowance, levied on income from employment, any pension and certain benefits. In the 2025/26 tax year it’s £12,570. You can raise this to £15,700 in the case of certain benefits – and lower it if you earn over £100,000. If you earn more than £125,140, your Personal Allowance disappears completely. 

On top of this you get a Personal savings Allowance, which applies to income from Individual Savings Accounts (ISAs), and this is £1,000 for basic-rate and £500 for higher-rate taxpayers. Additional rate taxpayers are not eligible. 

So far, so good, but what of pensions? When you turn 55 you can take up to 25% of your aggregated personal and workplace pensions, tax-free. 

As you might expect, there is a caveat: you have a Lump Sum Allowance of £268,275, which sits across the entirety of your pensions, not each one. Simple arithmetic says you will be fine if your aggregated pensions are worth £1,073,100 more or less.  

There’s a further caveat here (you probably know tax is so complex that any summary will be full of caveats): This Lump Sum Allowance may also rise in certain circumstances. Please get in touch if you’d like to know more. 

Moreover, taking that 25% lump sum might push you into a higher rate. If this is something that could affect you, it might be worth spreading your pension payments across several tax years, to reduce your tax liability and manage your portfolio more effectively. 

The State Pension 

As we mentioned, your State Pension income is taxable, but they pay it to you gross of tax. For example, say you get paid £5,000 a year from your private pension and £11,500 from the State Pension. Here, your private pension provider will usually contribute the tax applicable to the whole £16,500. 

There are circumstances in which you might not get the full State Pension amount. It is hugely important to check whether you have made sufficient National Insurance contributions. 

In essence, you need to have paid NI for at least 10 qualifying years to receive a State Pension at all – and 35 qualifying years of NI to receive the full amount, of £230.25 a week. 

If you’ve not kept up your National Insurance contributions, you can find out quickly and simply on the Government’s website. You’ll need your Government Gateway log in details – when you’re in, go to ‘Your National Insurance Record’. If you don’t have enough of a NI record, you can top up your credits for the last six years, to get you closer to eligibility. 

This is something we advise many of our client to do, simply because the income is guaranteed, and, for many, the additional contributions are more than outweighed by the income for life it can unlock. 

Longevity risk 

We all worry about running out of money. Drawing down from a pension, taking capital from your ISAs or other investments, selling a property will all deplete your assets. And, given we never know how long we have, it can be very hard to strike the balance between having enough – or running out.  

The State Pension is the one thing you don’t need to worry about. It pays out until you die and is not eligible for inheritance. 

In some cases, it might even pay out after that point. For example, a surviving spouse who hasn’t reached State Pension age might qualify for additional pension benefits. 

At a time when company and private pension assets will soon become eligible for inheritance tax, the State Pension represents a very good deal. It may be small, but it is guaranteed and that’s a big help. 

If you’d like to know more about planning for retirement, please get in touch with one of our experts at hello@firstwealth.co.uk or on 020 7467 2700. 

This document is marketing material for a retail audience and does not constitute advice or recommendations. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.