12th August 2024
general
Frozen tax thresholds mean that, over the coming years, more people will pay a higher rate of Income Tax than previously. Some have dubbed this a “stealth tax”. Rather than affecting your tax position immediately, as wages rise over time, you could be pulled into a higher tax bracket.
It’s not just working-age people who will be affected by this. In fact, FTAdviser reports that the number of retirees paying Income Tax has risen to 8.5 million in 2024/25, an increase of 660,000 from 2023/24.
Fortunately, there are some simple steps you can take to improve your tax efficiency in retirement. Read on to learn why more retirees are paying Income Tax than before, and how you can mitigate your bill.
Frozen tax thresholds mean that, as the State Pension rises over time, more retirees will be pulled into higher tax brackets
The triple lock guarantee is the government’s commitment to raising the State Pension in line with the cost of living. So, each year, the full State Pension would rise by the highest of:
At the same time, the government has frozen Income Tax thresholds until 2027/28. As such, you could soon find yourself in a higher tax bracket than you are used to.
This is why tax planning is so important in retirement.
By being strategic about how you withdraw from your savings, you could mitigate your tax bill and put more of your wealth towards creating your preferred lifestyle. Read on to learn more.
5 practical ways to mitigate your Income Tax bill in retirement
1. Make the most of your 25% tax-free lump sum
When you first retire, you can usually withdraw up to 25% of your pension tax-free either as a lump sum or as multiple smaller withdrawals. If you choose the latter option, 25% of each smaller withdrawal would be tax-free.
Any pension withdrawals you make above this 25% tax-free threshold will count towards your taxable income, so you may need to pay Income Tax at your marginal rate. Larger pension withdrawals could push you into a higher tax bracket, so it’s important to keep track of how much income you are taking when you retire.
Your financial adviser can help you to decide on the most suitable way to access your pension and use your tax-free lump sum if you choose to withdraw it.
2. Use other savings, if you’re able to, before dipping into your pension
If you hold savings or investments in an ISA, it may be worth considering using these before you dip into your pension.
An ISA is a tax-efficient way to save, since you don’t pay Income Tax or Capital Gains Tax on interest or returns that you accumulate in this wrapper. Because withdrawals from an ISA would not be counted as taxable income, this could offer a more tax-efficient way to fund your retirement in the early years.
Leaving your pension invested for longer may allow it to grow. This does expose your savings to risk, as investments can fall in value as well as rise.
An added benefit is that your pension is usually considered outside of your estate for Inheritance Tax (IHT) purposes. So, it could be a tax-efficient way to pass on assets to your loved ones if this is a priority for you.
3. Check that your tax code is correct
The complexity of the tax system means that many retirees are placed on an emergency tax code after their first pension withdrawal. This is because HMRC assumes that you will make the same withdrawal each year. So, if you’re withdrawing a large lump sum that is intended to fund your lifestyle for several years, you could end up overpaying tax.
It’s sensible to check and update your tax code on the government website after your first flexible withdrawal to ensure your records are correct. It’s also possible to claim a tax refund if you find that you have overpaid.
4. Plan your retirement income with your partner
If you have a spouse, planning your retirement income together could be a helpful way to make the most of your individual tax allowances.
For example, you each have a tax-free Personal Allowance of £12,570 in 2024/25. So, as a couple, you could take a combined annual income of £25,140 before Income Tax would be payable. What’s more, the threshold for paying higher-rate Income Tax in 2024/25 is £50,270. So, as a couple, you could have a combined income of £100,000 a year while still paying basic-rate Income Tax.
Planning your retirement income together has the added benefit of ensuring you make the most sensible financial decisions for you as a couple. This could help you to achieve your goals more quickly.
5. Continue to meet your financial adviser regularly throughout your retirement
Your financial adviser can provide invaluable guidance on tax planning throughout your retirement to ensure you continue to make the most of the allowances available to you. This may be particularly helpful as tax legislation can change frequently, making it challenging to stay up to date.
As well as helping you to spend and save tax-efficiently, they can also help you to create a plan that mitigates a potential IHT bill on your estate after you pass away. In doing so, you can reduce the financial strain your loved ones may face during a time of grief later on, while also ensuring your family inherit more of your wealth.
Get in touch
To find out more about how we can help you to create a tax-efficient retirement income strategy, please get in touch.
Email enquiries@jesellars.co.uk or call 01934 875 919 to start the conversation.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning or tax planning.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
