You might picture retirement as sun-soaked beaches, golfing, or lazy afternoons filled with long meals. But the reality is that many retirees are still dealing with taxes. Recent figures from HM Revenue & Customs show that the percentage of those over 75 paying taxes increased from 7% in 2011-12 to around 11% in 2022-23. That equates to approximately 7.13 million people of pension age contributing taxes last year.
Currently, almost 21% of taxpayers are pension recipients, accounting for about 7% of the overall tax revenue. With the new state pension expected to surpass £12,570 in the coming years, those preparing to retire face a competitive landscape, particularly with capital gains tax and inheritance tax also on the rise.
Given this, careful tax planning has become essential. If you’re nearing retirement or are already in it, there are a few significant considerations to keep in mind.
Before Retirement
It’s crucial to begin your tax planning before you leave the workforce. The years leading up to retirement can be leveraged for tax-efficient savings and investments.
Start with your pension. You can contribute up to £60,000 annually, which not only boosts your pension fund but also lowers your take-home salary, lessening your income tax burden.
According to the National Bureau of Statistics, the average pension pot for those aged 55-64 stands at £137,800. Wealth managers like M&G suggest that if you invest £10,000 annually, you could grow that to £373,232 in ten years, assuming a 4% annual growth rate post-fees.
Chris Etherington from RSM points out, “An important benefit of making pension contributions now is the possibility to lower your income tax liability, especially if your income is on the lower side. You can defer this until later when you might be in a lower tax bracket.”
Next up, consider ISAs. You can deposit £20,000 each tax year into these accounts. While there’s no tax relief on the contributions, any profits or withdrawals remain tax-free.
Once your ISAs are at their limit, you might explore other savings options like premium bonds, which allow for tax-free winnings of up to £1 million through monthly draws.
Investing in an enterprise investment scheme or venture capital trust can also be beneficial. If you meet specific criteria—holding shares for at least three years for the Enterprise Scheme or five years for the Venture Capital Trust—you can earn a 30% income tax credit on those investments.
However, it’s worth noting that while tax credits can be quite appealing, Etherington cautions that such investments usually involve a higher risk due to their nascent stage.
If you’re married, make sure your assets are allocated efficiently. Take advantage of the marriage allowance if one spouse has stopped working or has a low income, allowing for a transfer of a portion of their personal allowance to the other, potentially saving you up to £252 in income tax.
“Make sure any income-generating investments, like rental properties, are under the name of the spouse with the lower tax bill. HMRC divides revenue evenly for jointly owned assets,” advises Barrie Dawson of M&G.
Early Retirement
The thought of continuing to work may not appeal to those dreaming of freedom, but it could actually be a savvy tax move. Once you reach the state pension age (currently 66, moving to 67 between April 2026 and March 2028), you’re exempt from national insurance.
This tax normally encompasses 8% of weekly earnings between £242 and £947, which corresponds to a tax-free allowance of £12,570 and a high-income threshold of £50,270 annually.
Interestingly, about 9.5% of individuals over 66 are still in the workforce, according to Age UK, a figure that has risen from 8.7% a decade ago.
Those who continue working have the option to postpone their state pension, potentially increasing its value by 1% for every nine weeks of delay. If you hold off for a year, this leads to a growth of approximately 5.8%. This year, the new state pension sits at £230.25 weekly, with an added £13.35.
Whether delaying will prove beneficial hinges on how much tax you might incur on the pension and how long you decide to defer it. At £13.35 a week, it would take over 17 years of postponing to surpass a year’s worth of pension without factoring in taxes or future payments.
Moreover, you’re eligible for tax-free earnings up to £31,570 each year, with savings interest providing an extra £5,000 before taxes kick in for those below the personal allowance threshold.
If you go over £12,570, your allowance will begin to taper off £1 for every pound earned above that threshold, disappearing entirely once you hit £17,570.
This basic rate can be added to a personal savings allowance of £1,000 for basic-rate taxpayers—though higher earners receive a reduced allowance and none for additional rate taxpayers.
Those investing outside of ISAs can earn up to £500 in dividends and £3,000 in capital gains before they hit taxes.
There are also tax benefits in pursuing side gigs while retired. You can earn up to £1,000 tax-free through casual incomes, like dog walking or crafting. Additionally, if you rent out a garage or storage space, that income is also tax-exempt.
For those with spare rooms, there’s another opportunity: the rental room scheme allows for tax-free income up to £7,500, provided the rooms are adequately furnished. This allowance is per household, effectively halving the sum for couples.
After Retirement
Once you start withdrawing from your pension, it’s vital to think carefully about your withdrawal strategy. You can take up to £268,275 tax-free, which is 25% of your total pension pot. However, unless it’s an immediate necessity, a more gradual approach makes sense, enabling the remaining funds to grow.
Gradual withdrawals help manage taxable income and keep you from jumping into higher tax brackets, according to Shah.
Flexible drawdowns offer the option to withdraw as needed rather than sticking to a set amount, making tax management easier. For instance, consider reducing withdrawals for a few years to facilitate capital gains.
It’s also wise to keep your will updated. The Money and Pensions Service notes that 53% of individuals aged 50-64 lack wills, with 22% of those over 65 in the same boat.
For those who die intestate, assets are distributed per intestacy rules instead of individual desires, potentially exposing parts of their estate to inheritance tax that could have been avoided with a proper estate plan.
Furthermore, you might consider inheritance tax strategies, such as utilizing gift allowances. Although the £3,000 annual exemption and £250 small gift exemption seem minor, when used strategically, they can lower overall inheritance tax exposure, as Dawson notes.
If you live in a gift for seven years, those amounts can also be exempt from taxes.
Additionally, if you redistribute surplus income without affecting your standard of living, those amounts can also escape inheritance tax. Good record-keeping is essential since TWM law firm saw a 177% increase in amounts given under this rule during the tax year 2023-24 compared to the previous year.
Finally, consider the assets you could inherit from your partner. While there won’t be inheritance tax on what a spouse or civil partner leaves behind, inheriting ISAs can also extend tax advantages, allowing you to enjoy a larger tax-free allowance even if some assets go to others.
Pensions will generally pass on to a spouse without facing inheritance tax after April 2027. Still, if your partner dies post-75, you’ll need to manage withdrawals prudently to stay beneath the tax threshold, as income tax will apply to pension distributions.
For those keen on sidestepping inheritance tax, relocating to a different country might be worth considering. Some places, like Portugal and Canada, don’t impose inheritance taxes, though navigating through local laws and regulations is crucial.
“If someone spends significant time abroad, their non-UK assets may no longer be subject to inheritance tax,” Etherington suggests, though understanding the new country’s tax system and potential equivalent taxes is vital.
