Tax in retirement – what you’ll need to know


At a glance

  • You’ve got far more flexibility in how you plan your retirement income now, but there are a few tax-traps to look out for.
  • Paying tax when you’re working is quite different to paying tax when you’re retired, so take advice before you make any sudden or costly choices.
  • SJP advisers can point you in the right direction and make sure you take your retirement income tax-efficiently.

Once upon a time, when you retired, you pretty much stopped paying into your pension and started drawing it. However, the 2015 reforms to Defined Contribution (DC) pensions, mean that many people stay invested during retirement. The process is now much more seamless, and for some people very little really changes.

But there are big changes when you do start drawing your pension, and it’s important to be aware of them. Perhaps the most obvious is the way in which you’re taxed. While there are more opportunities to be tax-efficient, there are also a few more pitfalls that you’ll want to avoid.

Do you pay tax in retirement?

Your tax situation can alter significantly, as Tony Clark, Senior Propositions Manager at St. James’s Place, points out. “When you retire, you do have a lot more control over how you take your income, and what tax you pay,” he explains. Most people are aware that you can still pay Income Tax in retirement, but you won’t have to pay National Insurance contributions after hitting State Pension age.

“Lots of people have built a broad mix of savings, investments, and assets. You could well have pensions, Cash ISAs, Stocks & Shares ISAs, property, part-time earnings and so on. It’s up to you to choose how and when you draw money from these – and those income sources are treated and taxed differently.”

Taking your retirement income

Working out what’s best and most tax-efficient for you in retirement can feel daunting, simply because there are now so many more options. For many people, the baseline will be their pension. Be aware, though, that only the first 25% that you draw from a Defined Contribution pension is tax-free. After that you’ll be taxed at your marginal rate. So what other options might you have to fund the retirement you’ve been planning?

If you have money saved in ISAs, you won’t pay Income Tax on any withdrawals you make. So you could take income from there. This is one of the reasons that it pays to spread your assets over several sources. “Lots of people don’t realise this,” says Clark “They’ll rely heavily on a pension income and get hit with a tax bill just because they didn’t know they had other options. Planning income in later life is one of the key things we help our clients with.”

Look out – tax hazards ahead

There are several other tax-related pitfalls you should know about. Since the reforms of 2015, a number of people have had to pay Emergency Tax when they’ve taken a lump sum from their pension – over and above that first tax-free 25%. As far as HM Revenue & Customs, the HMRC are concerned, that’s taxable income. Emergency Tax kicks in and it can be hard work to reclaim what you might be owed.

“Even if you take a £10,000 lump sum, HMRC will see it as income of £10,000 and they’ll tax you accordingly,” Clark explains, “So you need to be on top of your HMRC account and make sure it’s set up correctly, so they know it’s a one-off withdrawal, and not going to happen on a regular basis.”

Similarly, taking a lump sum from a pension pot could push you up into a higher tax band, particularly if you’re a basic-rate taxpayer just below the higher-rate threshold. Again, this is because HMRC sees that lump sum as income.

“However, you could use the different tax years to your advantage here,” says Clark. “For example, if you take £5,000 in one tax year and £5,000 in the following tax year, you might be able to stay under the higher-rate threshold.”

Can I avoid paying too much tax?

To avoid paying more tax in retirement than you need to, it pays to have a financial adviser onboard to create the best and most tax-efficient plan for retirement income. Tax regulations are complex, and they change regularly, so you need somebody who can flag the ones that might affect you personally. Together, you can decide your best course of action – and get on with enjoying the retirement you’ve imagined.

“As you’re coming up to retirement, you need clear, practical and personal advice on your tax situation, because it is quite different from how you’re taxed when you’re working,” says Clark. This is true whether you’re a few years away from stopping work or about to plan your retirement party.

If you know that you’re going to have a combination of Defined Contribution (DC) and Defined Benefit (DB) pension pots, proper financial advice is really key. That’s because the income from a DC pension will be paid to you whether you want it or not, and it will be taxed. So, it’s important to know where you can avoid paying too much tax, and where you can’t.

Living later life to the full

“Our SJP advisers help you see the bigger picture and understand which of your assets will be taxed, and which won’t,” says Clark. “A lot of us want to kick start our retirements with lump sums, so we can travel, or move house – we’ve got big dreams in later life. So you don’t want to take your eye off the ball at the last minute.”

The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

The levels and bases of taxation and reliefs from taxation can change at any time and are generally dependent on individual circumstances.

SJP Approved 30/01/2023


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