Your retirement should be a golden chapter in your life. Ensure you're financially prepared for the journey ahead with our guide to tax-efficient retirement planning.
"You are never too old to set another goal or to dream a new dream."
C.s. Lewis
01.
Navigating the retirement tax landscape
Calculating tax on your pension pot
02.
Exploring other types of taxes
03.
Paying your pension taxes
04.
Understanding pension tax relief
05.
Five strategies to reduce your retirement taxes
06.
Tax considerations in special circumstances
07.
A guide to tax in retirement
A playbook for perfecting your tax plan.
This article is not advice. If you would like to receive advice on your taxes and investments, consider speaking to a Financial Adviser.
Friday, 16 February 2024
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08.
How taxes are applied to different retirement incomes
albert einstein
"The hardest thing to understand in the world is the income tax."
HM Revenue and Customs (HMRC) is the main tax authority when it comes to UK retirement income. HMRC collects taxes, like Income Tax, from different sources of your retirement income. Income Tax is a significant consideration for pensioners, as it’s often levied on income from your State Pensions, private pensions, and savings.
State Pension
Workplace pensions
Private pensions
Annuities
Investment income
State Pension is subject to Income Tax, but you’ll receive the entire amount (without tax deducted at the source). If the State Pension is your only source of income, the tax is collected through the annual Self Assessment tax return process.
Contributions to workplace pensions benefit from tax relief. They’re usually deducted from your salary before Income Tax is applied. This reduces your taxable income. When you retire, you can usually take a portion of your workplace pension as a tax-free lump sum. The rest is subject to Income Tax when you withdraw it.
Like workplace pensions, contributions to private pensions benefit from tax relief. The tax treatment at retirement is similar to workplace pensions, with a portion available as a tax-free lump sum. The rest is subject to Income Tax when you withdraw it.
The income received from an annuity is subject to Income Tax. The tax is typically paid at source by the annuity provider. The tax treatment will vary based on the specific terms of the annuity.
Dividends are subject to different tax rates, with a tax-free dividend allowance, basic rate, higher rate, and additional rate. Interest from savings may be subject to the Personal Savings Allowance (PSA), which allows you to earn a certain amount of interest tax-free.
Navigating retirement taxes: a beginner's guide
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Modern day financial planning for retirement
Once you retire, you’ll pay Income Tax on any income exceeding your Personal Allowance, including your pension payments. 25% of your total pension pot will usually be tax-free. The other 75% is treated as ordinary income and, as a result, is subject to tax.
The rates are slightly different in Scotland, due to different tax bands.
Basic rate The lowest level of Income Tax you’ll pay if you have an income between £12,571 to £50,270.
20%
Higher rate The middle tier of Income Tax you’ll pay if you have an income between £50,271 to £125,140.
40%
Additional rate The top rate of Income Tax you’ll pay if you have an income over £125,140.
45%
Income Tax is charged at three rates:
How much Income Tax will I pay on my pension?
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Inheritance Tax and Capital Gains Tax are specific types of taxes that relate to the transfer of assets, particularly when a person inherits property or investments. Understanding how they work is important for managing finances effectively.
Inheritance Tax
Capital Gains Tax
Inheritance Tax is a tax charged on the value of your estate when you pass away. Your estate includes assets such as property, investments, savings, and possessions. If the total value of your estate exceeds a certain threshold, your beneficiaries may have to pay Inheritance Tax. There are thresholds, called the ‘nil-rate band’ and the ‘residence nil-rate band’. These determine how much of your estate can be passed on without Inheritance Tax. There are also other types of exemptions and reliefs available for gifts (such as money, property, jewellery, or antiques). These can lower Inheritance Tax. From 6 April 2027 any unused pension funds, or death benefits left when someone passes away, will be counted as part of their estate. This means they will be subject to Inheritance Tax.
If you sell certain assets like a property, shares, or investments, and make a profit, you'll have to pay Capital Gains Tax. It’s the gain you make that’s taxed, not the amount of money you receive. For example, if you buy artwork for £10,000 and sell it for £15,000, the £5,000 gain is what's taxed, not the entire £15,000 you receive. There is also a tax-free allowance known as the Annual Exempt Amount, currently set at £6,000. If your profits in a tax year fall below this, you won’t pay Capital Gains Tax.
Paying tax on your State Pension and private pension is simple. Your pension provider takes care of it for you. They deduct tax from your pension payments, which usually happens monthly or weekly. They use a tax code provided by HMRC, based on your personal situation, to determine the right amount of tax. If you receive payments from multiple pension providers, HMRC will instruct one provider to manage your State Pension tax. At the end of the tax year, your pension provider will send you a P60, which shows the amount of tax you've paid throughout the year. If you've overpaid, you can ask for a refund.
When it comes to the State Pension, if you owe any tax, it's your responsibility to pay it. The amount of tax you owe depends on your total income. This includes not only your State Pension but also any other sources of income you may have, such as earnings from part-time work. If you started receiving your State Pension on or after 6 April 2016, you won't need to send a tax return. Instead, HMRC will let you know the amount you owe and provide instructions on how to make the payment. However, if you started your State Pension before this date, you'll need to file a Self Assessment tax return to report and pay any tax you owe.
Both State Pension and private pension
State Pension only
How you pay tax depends on the kind of pension you get, and whether you have any other source of income.
Limits on tax relief
Pensioners can get tax relief on their pension contributions. But there are rules on how much you can save each year to gain tax relief. Below are two limits you should be aware of - the Annual Allowance and the reduced (tapered) annual allowance.
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Your employer deducts tax from your taxable earnings. They then deduct your pension contribution from your after-tax pay and send it to your pension provider. Your pension provider claims 20% in tax relief directly from the government, adding it to your pension pot. For example, if you contribute £80 to your pension, your provider will claim an additional £20 in tax relief, resulting in a total contribution of £100 to your pension pot.
A boost to your pension contributions from the government.
This method is commonly used for personal pensions, SIPPs, and stakeholder pension schemes.
Relief at source
How does tax relief work?
There are two primary methods for obtaining tax relief on your pension contributions:
How much tax relief will I get on my pension?
Pension tax relief is a government incentive to encourage people to save for their retirement. When you contribute to your pension, some of the money that would typically go to the government as tax is redirected into your pension fund.
Basic rate taxpayers For every £100 you contribute to your pension, the government adds £20 in tax relief. So, your pension pot increases to £120 with just a £100 contribution.
Higher rate taxpayers You can claim an extra £40 for every £100 you contribute to your pension. So, if you're in the 40% tax band and put £100 into your pension, it grows to £140 with tax relief.
Additional rate taxpayers For every £100 you contribute, the government adds £45. So, a £100 contribution becomes £145 in your pension fund.
Your employer deducts the full amount of your pension contribution from your pay before any tax is deducted. You pay tax on your earnings minus your pension contribution, resulting in a lower tax bill and more take-home pay.
Pension contributions are deducted before tax, potentially resulting in lower tax payments.
This method is often used in workplace pension schemes.
Net pay
How it works
If you pay higher rates of tax (for example, 40% or 45%), you can claim additional tax relief on your contributions through your self-assessment tax return.
Annual Allowance
Reduced annual allowance
A limit on the amount you can contribute to your pension each tax year, while still receiving tax relief. It factors in contributions made by you, your employer, or third parties on your behalf (such as family members). Contributions exceeding the Annual Allowance may lead to a tax charge. The Annual Allowance for the current tax year is £60,000.
This further limits how much tax relief you can claim on your pension savings. Your allowance may reduce depending on your income. However, everyone keeps an allowance of at least £10,000. If your adjusted income exceeds £260,000, your Annual Allowance decreases. If your threshold income is £200,000 or less, your Annual Allowance remains unaffected, regardless of your adjusted income. For every £2 your adjusted income exceeds £260,000, your Annual Allowance decreases by £1, with a minimum reduced allowance of £10,000.
next
01
02
Consider using tax-free ISAs for your investments and savings. Money held within ISAs grows tax-free, and you won't pay Income Tax on withdrawals.
ISA (Individual Savings Account)
Put more money into your pension fund. The government gives you a tax break for doing this, which means you'll pay less tax.
Pension contributions
Invest in tax-efficient funds, such as those with Capital Gains Tax advantages. These can help minimise the tax you pay when you sell them.
Pick smart investments
Use accounts that don't tax you
Top strategies for earning more interest on your savings
Diversify your retirement income sources to manage tax liability. This may include a combination of State Pensions, workplace pensions, private pensions, cash and other investments.
Use different sources of income
By spreading out withdrawals from retirement accounts over time, you can potentially keep your taxable income within lower tax brackets and reduce the overall tax you’ll paid.
Take money out wisely
Spread out your money
Delaying your State Pension can lead to a higher pension amount when you eventually claim it. Additionally, you'll receive a 1% increase for every nine weeks you defer. This can provide a larger income in later years when you might have fewer taxable sources of income.
Defer your State Pension
03
Wait to get your State Pension
Take advantage of the annual Capital Gains Tax allowance, which allows you to make a certain amount of profit from asset sales tax-free.
Use the annual exempt amount
04
Be smart about selling
If you have investments that aren't doing well, you can sell them to lower your tax bill. The losses you make can help reduce your overall Capital Gains Tax liability.
Sell underperforming investments
Make use of gift allowances to reduce the value of your estate for Inheritance Tax purposes. In the UK, there are annual gift allowances and a seven-year rule for larger gifts. Gifting assets to family members can minimise the impact of Inheritance Tax on your estate.
Gift allowances
Consider setting up trusts or using estate planning strategies to protect your assets (such as money and property). This could potentially reduce the impact of Inheritance Tax.
Trusts and estate planning
05
Plan for what happens after you're gone
By using the allowances and reliefs available, it's possible to significantly reduce, or even eliminate, future tax charges on your retirement income. Here are five strategies to consider to help you minimise retirement tax.
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If you choose to claim your State Pension early, it may be subject to deductions, particularly if you haven’t made enough National Insurance contributions. The State Pension age is gradually increasing, so claiming it early might reduce your annual payments.
Early retirement
Taking your pension money as retirement income
When you retire early, your tax situation can change, especially if you start drawing your pension before your State Pension age.
key considerations
When you access your pension funds early, a portion is tax-free (usually 25%), while the remaining portion is subject to Income Tax at your rate. You can take your entire pension pot as a lump sum, but this may result in a significant tax bill.
Workplace and private pensions
Your pension income, combined with any other earnings you make, can push you into a higher tax bracket. You may need to adjust your tax code to ensure you're paying the right amount of tax.
Income Tax
Moving abroad or becoming a non-UK resident can have significant tax implications.
You can generally receive your UK State Pension overseas, but annual increases may not apply in certain countries. Eligibility depends on the ‘triple lock’ policy and your country of residence.
Retiring abroad or becoming a non-UK resident
You can often continue to receive these payments abroad. The tax treatment may depend on the tax laws in your country of residence and any double taxation agreements between the UK and your new country.
If you own property or assets in the UK, they may still be subject to UK Inheritance Tax. It’s worthwhile getting legal advice to understand your obligations.
Becoming a non-UK resident means you could no longer be liable for UK Income Tax on your worldwide income. Instead, you might pay tax in your new country of residence.
Non-resident tax status
If you sell UK property or assets as a non-UK resident, you could still be liable for UK Capital Gains Tax. Again, it’s helpful to get professional advice on the rules and exemptions.
Whether you're considering retiring early or moving abroad, we highlight some of the key tax implications you might encounter along the way.
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