If you keep the money in the pension so you can take an income from it – either flexibly, as a guaranteed income (annuity), or as a scheme pension – there’s a 25% tax charge.
This is on top of any income tax you pay on the income you receive.
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 out of your pension pot, leaving you with the remaining 75% to use towards your retirement income.
For example, if someone who pays tax at the higher rate had 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%, the person would be left with £450 a year.
This means the lifetime allowance charge and Income Tax combined have reduced the income by 55% – the same as the lifetime allowance charge if the benefits had been taken as a lump sum instead of income.