After spending many years working and paying taxes, you would be forgiven for expecting little/no taxes in retirement. However, pensioners still face various tax liabilities after taking benefits. In this guide, our Carlisle financial planners explain the primary taxes bearing upon retired people in 2024, together with ideas on how to reduce their impact on your finances. We hope these insights are helpful. Please contact us for more information or to speak with a financial adviser:
t: 01228 210 137`
e: [email protected]
Income tax
From the UK government’s perspective, income from your pensions is regarded as “earnings” and, therefore, falls under the Income Tax category. This is true whether you make gradual withdrawals from your pension pot (via “flexi-access drawdown”) or you use pension funds to buy a retirement income using an annuity.
In 2023-24, your pension income is completely tax-free if the total amount falls under your Personal Allowance (£12,570 per year). However, many pensioners are likely to earn over this amount when adding up income from their State Pension and various schemes (e.g. old workplace pensions and private pensions).
Therefore, retired people – and those approaching retirement – need to be mindful of different Income Tax bands and rates so they can plan accordingly. In 2023-24, the UK (excluding Scotland) taxes pension earnings at 20% (the Basic Rate) for earnings between £12,571 to £50,270. After that, the 40% Higher Rate applies to earnings up to £125,140 – at which point, the 45% Additional Rate is levied.
What can people do to reduce unnecessary Income Tax in retirement? One idea is to limit your withdrawals each tax year (if affordable and appropriate). For instance, a pensioner using flexi-access drawdown and receiving the full new State Pension might choose to lower his withdrawals from the former – keeping his total income below £50,270 to keep out of the 40% Higher Rate.
Another idea is to be strategic with your tax-free pension lump sum. In 2023-24, an individual can withdraw up to 25% of their pension savings from the age of 55. This can be done all at once or in multiple lump sums. Here, a pensioner might consider taking the latter approach – e.g. spreading tax-free withdrawals across different tax years to keep out of the Higher Rate.
Savings
Like people of working age, retired individuals are each entitled to a Personal Savings Allowance (PSA) which allows for tax-free interest to be earned. In 2023-24, the tax-free threshold is £1,000 per year for a Basic Rate taxpayer. For those on the Higher Rate, it is £500. For Additional Rate taxpayers the PSA is effectively eliminated.
It can be harder to build up your savings in retirement because you likely no longer earn a salary. Your finances are likely more focused on living off your savings. However, your existing savings may still be subject to tax if you are not careful. For instance, in 2024 interest rates from savings accounts have risen compared to 2021 (when the UK’s base rate was near zero). Consequently, many savers in retirement are crossing their tax-free threshold for earning interest – often inadvertently and unknowingly.
To guard against this, you can explore various options with a financial adviser. For instance, it may be appropriate to move certain savings into Premium Bonds (which offer the chance of a cash prize rather than a guaranteed interest rate). Another option might be to put regular savings into a Cash ISA. In 2023-24, an individual can contribute up to £20,000 per year to their ISAs and receive tax-free dividends, capital gains and interest (in addition to their PSA).
On this subject, an individual’s ISAs can also be valuable for managing Income Tax. For instance, rather than purely supporting your lifestyle using pension income, you could consider also using funds from your ISA(s). These are not regarded as earnings and so will not count towards your Income Tax liability.
Inheritance tax
Retirement is often the time of life when estate planning becomes a more pressing topic. In 2023-24, the standard rate of inheritance tax (IHT) is 40% on the value of a deceased person’s estate once it exceeds £325,000.
Here, your pension could play a vital role in your financial plan. In 2024, a defined contribution pension (i.e. a pension “pot”) is generally not treated as part of an individual’s estate for IHT purposes. This means that any remaining funds inside it can be passed down, IHT-free, upon death to beneficiaries.
This tax rule can provide further incentive for an individual to consider drawing from ISA savings earlier in retirement, rather than taking their income entirely from pension pots. Assets inside ISAs (e.g. cash) are unlikely to qualify for IHT relief, so focusing on these first (as income sources) can sometimes achieve multiple tax planning objectives at the same time. There are, however, circumstances in which pensions may be treated as part of an individual’s estate which a financial adviser can help with.
Invitation
If you would like to discuss your financial plan and investment strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
e: [email protected]
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.