If you keep the money in the pension so you can take an income from it – either flexibly (pension drawdown), as a guaranteed income (annuity), or as a scheme pension – there’s an immediate 25% tax charge.
This is on top of any Income Tax you pay on the income you receive, when you receive it.
For defined benefit pension schemes, your pension scheme might decide to pay the tax on your behalf and recover it from you by reducing your pension.
For defined contribution pension schemes, your pension scheme administrator should pay the 25% tax to HMRC from your pension pot, leaving you with the remaining 75% to use towards your retirement income.
Example: someone who pays tax at the higher rate expected to get £1,000 a year as income but the 25% lifetime allowance charge reduced this to £750 a year. After Income Tax at 40%, they would be left with £450 a year.
This means the lifetime allowance charge and Income Tax combined have reduced their income by 55% – the same as the lifetime allowance charge if they had taken their benefits as a lump sum instead of income.