It takes half a lifetime to build it up, so the prospect of giving your hard-earned and painfully saved retirement income to the government is far from pleasant.
But that is probably what will happen. Although the irritation of National Insurance contributions disappears once you are retired, you can still be hit for Income Tax, Capital Gains Tax and Dividend tax.
You would probably like to keep the cash to fund your golden years, rather than share it with HMRC.
At Continuum we are looking at whether that is possible – or at least, if there may be ways to reduce the level of tax you have to pay in retirement.
The retirement tax challenge
The tax rules are just the same when you retire as when you are working. For the tax year 2025/2026, you will have a basic personal tax allowance of £12,570 and start paying income tax on anything above. With the full new state pension increasing to £11,973 per year in 2025/2026 you could find yourself paying income tax even with a modest employers or private pension.
Anything above this is taxed at your marginal rate of income tax, which is driven in turn by your total level of income. If your pension provision means an income larger than £50,271, you will pay higher rate tax (currently 40%).
You can decide how much you withdraw from your pension pot. The challenge is to have sufficient income, while keeping under the appropriate tax threshold.
Keeping your income under the basic allowance and still enjoying a decent quality of life may be difficult and paying some tax may be inevitable – the challenge is to pay as little as possible.
Should you take your tax-free cash?
The first 25% of a pension fund is tax-free and is yours to use as you wish.
You might need to pay off your mortgage or clear up other loans.
But you are under no obligation to take the first 25% all at once. One alternative is may be to spread the withdrawal of this tax-free sum over time – for example rather than taking £25,000 as a lump sum you could take £2,500 per year over ten years. This could provide the level of income you actually need, without triggering an Income Tax liability.
Another option could be to defer taking the lump sum, allowing it to potentially grow (while keeping in mind the risks of stock market investments). If you retire with a pension fund of £80,000 your 25% tax free cash amount would be £20,000. If you leave this within your pension and your pension fund grows this would increase your tax free cash amount, for example, if your pension fund increased to £100,000 your tax free cash amount would be £25,000. However, please be aware that if your pension fund decreased in value then so would your tax-free cash. (Generally, you can take a tax-free lump sum from your pension of 25% of your pension pot, up to a maximum across all your arrangements of £268,275)
You could even take your tax-free lump sum and invest it in a tax efficient ISA (Individual Savings Accounts), ensuring that there would be no income tax to pay, however much growth it enjoyed.
if you take a tax-free lump sum from your pension, that amount will remain tax free. However, if you invest it in a standard savings or investment account, any growth such as interest, dividends or capital gains may be subject to tax. by investing the lump sum in a tax efficient wrapper such as an ISA, you can help ensure that both the original amount and any future growth remain tax free
Consideration may now need to be given to the changes announced in the Autumn 2024 budget, where most unused pension funds and death benefits will become part of your estate for Inheritance Tax purposes from April 2027.
Use that ISA
When it comes to ISAs any income generated from your ISA savings or investments is completely tax-free. This means it doesn't count towards your taxable income, allowing you to enjoy as much of your ISA income as you wish without it affecting your tax bracket. Unlike pension income, which is subject to taxation, ISA income currently remains untaxed. Therefore, it might make sense to focus on building up your ISAs before retirement and then utilize them once you retire. Currently the maximum amount you can invest into an ISA is £20,000 per year.
Spread the load
If you are a couple, you both have a personal allowance of £12,570, meaning that together you can shield just over £25,000 from Income Tax.
But income tax is not the only challenge. If you are cashing in investments, Capital Gains Tax starts to become a problem. If you are married or in a civil partnership, it could mitigate the taxman’s share by giving you two CGT allowances instead of one.
Getting some expert help
Tax is just as complicated after you retire as it was when you were working, and the need to get expert advice to guide you through the maze of the tax system is just as great. At Continuum we can work with you to help make the most of your allowances and entitlements, and the most of your pension pot.
The sooner you call us, the more we can do for you – and the more potential there can be for mitigating your tax bill.
Why not calling us today?
Autumn Budget 2024: Pensions to be subject to inheritance tax
The New State Pension Amount – What You'll Get | Age UK
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable Retirement or investment strategy, you should seek independent financial advice before embarking on any course of action.
The value of an investment can go down as well as up and you may get back less than you invested. When investing Capital is at risk.
A pension is a long-term investment; the fund value can go down as well as up and this can impact the level of pension benefits available. Pension Income could also be affected by interest rates at the time benefits are taken. Pension savings are at risk of being eroded by inflation.
Investors in ISA’s do not pay any personal tax on income or gains, but ISAs do pay unrecoverable tax on income from stocks and shares received by the ISA managers.
The Financial Conduct Authority does not regulate taxation and trust advice or will writing.
Levels and basis of reliefs from taxation are subject to change and their value depends upon your personal circumstances. We recommend that the investor seeks professional advice on personal taxation matters.
