A guide to tax in retirement

Money Advice Service

Retirement brings with it a lot of change: change to your routine, to your income and changes to the amount of tax you have to pay. Find out how your pensions are taxed and when interest on your savings might be paid tax free.

Income Tax and National Insurance contributions

You still have to pay Income Tax after you’ve retired.

This applies to all your pension income, including the State Pension.

Many people assume that their pension income – especially the State Pension – will be tax free, but that’s not the case.

Some income, including your State Pension, is paid without any tax being taken off.

But if tax is due, this will often be collected by taking money off any company pension payments or when you take money out of a workplace or personal pension.

Income Tax personal allowances

You are able to earn or receive up to £12,500 in the 2019-20 tax year (6 April to 5 April) and not pay any tax.

This is called your Personal Allowance. If you earn or receive less than this then you’re a non-taxpayer.

How your pension is taxed

You can normally withdraw up to 25% of your pension pot tax free.

The remaining pot is used to provide an income or can also be withdrawn; in both cases this is taxable.

That means any money you receive over your Personal Allowance will be taxed.

Defined benefit pensions

If you have a defined benefit pension (also known as a final salary or career average pension) you can normally take up to 25% of your pension tax free, but you’ll be paid the rest as an income, which will be taxable.

Defined contribution pensions

The rules changed in April 2015 and you are now able to take as much money out of your pension as you want.

However, usually only the first 25% will be tax free. The rest is taxable. The amount of tax rate you pay increases when your income goes over certain thresholds.

This means that the more money you take from your pension pot, the higher your tax bill could be.

Find out more about how much tax you’d pay on your pension pot using the Pension Wise calculators.

Income from more than one source

In later life it’s quite common to have income from different sources. For example, you might still work part-time and have an income from your workplace pension and from some savings.

If you have income from more than one source, make sure HMRC know this so you pay the right amount of tax against each income.

Your personal allowance will normally be allocated against your main job or pension – usually the income that is more than the personal allowance.

If this is the case, any other income you receive will all be taxed either at 20%, 40% or 45%, depending on which tax band the other income falls into. Your PAYE code will have letters against it which tells you how much tax will be deducted from each income source.

However, if you have income from different sources below the personal allowance (£12,500 for 2019-20) you should ask HMRC to spread your personal allowance between the different sources of income to make sure you don’t pay too much tax.

If you do overpay tax, you can claim this back at the end of the tax year.

Make sure you check the tax code(s) so you know the right amount of tax is deducted.

Not sure whether your tax code is correct? The charity the Low Incomes Tax Reform Group has information about Checking your tax code.

Tax-free interest on your savings

The Personal Savings Allowance, introduced in April 2016, is the amount of savings income that can be received tax-free.

For 2019-20 this remains at £1,000 for basic rate taxpayers and £500 for higher rate taxpayers.

The previous option to complete form R85 to receive interest without tax taken off is no longer available.

Similarly, since April 2016, banks and building societies no longer deduct basic rate tax from the interest on your savings.

Instead, if your savings income is over £1,000 for a basic rate taxpayer and £500 for a higher rate taxpayer, HMRC will collect any tax due through your PAYE code.

If you normally declare savings income through a self assessment tax return you should continue to do this.

If your overall income is below the Personal Allowance (£12,500 for 2019-20) you are also entitled to the £5,000 ‘starting rate for savings’ of 0%, on top of the £1,000 Personal Savings Allowance.

You can still claim back tax you might have paid on your savings in previous years when you should not have done.

Use form R40 to do this.

Interest you receive from tax-efficient savings accounts, such as cash ISAs, is paid tax free whether or not you’re a taxpayer.

Find out more about the starting rate for savers and the Personal Savings Allowance in Tax on savings and investments – how it works.

National Insurance contributions

If you continue working beyond the State Pension age, you no longer pay National Insurance contributions on your earnings.

This article is provided by the Money Advice Service.

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