No-one wants to pay more tax than they need to, and with a bit of careful planning, there are plenty of legitimate ways to shelter as much of your retirement savings as possible from the taxman.
Frozen tax thresholds in recent years mean that many of us are paying more tax than ever. This is due to ‘fiscal drag’, whereby over time people earn more and their assets rise in value, but as tax thresholds have remained the same, they end up facing bigger tax bills.
Even those who have little other than the State Pension to rely on in retirement are being dragged into the tax net, especially as it will rise by another 4.1% from next April. You can find out more about this in our article What will the State Pension be in 2025?
Laura Suter, director of personal finance at AJ Bell, said: “The frozen tax bands combined with chunky increases in the State Pension mean that more pensioners are becoming taxpayers for the first time. For the current 2024/25 tax year we’re expected to see an extra 660,000 people over State Pension age pulled into paying tax. Since tax bands were frozen in 2021 there will be 1.77 million more taxpayers over the State Pension age – a 26% increase.”
Here, we look at five ways you might be able to keep your tax bills down so that your pension savings can stretch further.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
Try not to exceed your Personal Savings Allowance
If you have savings, make sure the interest you earn on this money doesn’t exceed your Personal Savings Allowance. The amount of tax-free Personal Savings Allowance you’re entitled to depends on whether you’re a basic, higher or additional rate taxpayer. Basic rate taxpayers, for example, can get up to £1,000 a year in savings income tax free. This reduces to £500 a year if you’re a higher rate (40%) taxpayer, whilst additional rate taxpayers don’t get a Personal Savings Allowance at all. Find out more in our guide What is the Personal Savings Allowance?
If you think you might be in danger of exceeding your allowance, then you may want to consider transferring some of your savings into ISAs (if you haven’t already used this year’s ISA allowance). You can save up to £20,000 each year into ISAs and you won’t have to pay any tax on your returns. Find the best cash ISA rates in our guide Best cash ISA rates – which cash ISAs pay the most interest?
Adam Thrower, head of savings at Shawbrook Bank said: “It’s shocking to know quite how many people could be sleepwalking into an avoidable tax bill by not paying attention to their savings. The Personal Savings Allowance has remained frozen since its inception, yet interest rates are much higher now compared to when this came into force, thus unaware savers could find themselves unnecessarily paying tax on their hard earned savings.”
Make the most of other exemptions and allowances
There are several other allowances that it’s worth making the most of in retirement if you want to keep your tax bills down. For example, if you have investments held outside an ISA, you can draw an annual income from dividends up to £500 and £3,000 in capital gains.You can learn more about the dividend allowance in our guide How are dividends taxed?
You can also earn up to £1,000 tax-free from casual trading, such as buying and selling things on ebay, and you can bring in a further £7,500 each year free of tax if you have a spare room to rent out. You can learn more about the government’s Rent a Room scheme in our guide Renting out a room – What you need to know.
Again, the best way to shelter your returns from tax is to use ISAs, as any gains will be free fro both income tax and capital gains tax. Gary Smith, Partner in Financial Planning at wealth management firm Evelyn Partners, said: “The narrowing opportunities for tax-exempt income and capital gains highlights the growing importance of ISAs in sheltering investments from dividend and capital gains tax.
“The annual £20,000 ISA allowance is a ‘use it or lose it’ one, and there is no guarantee a future government will not reduce that, so it is worth considering before the end of each tax year whether funds – which can be held as cash even in an investment ISA – can be committed to securing this allowance.” Learn more about ISAs in our guide Everything you need to know about ISAs.
Only take the amount you need from your pension each year
Pension income is taxed exactly like any other form of income, so if the money you get from your retirement savings exceeds your personal allowance (the amount of income you can earn each year without having to pay income tax) you must pay tax on it.
This tax year and next, the personal allowance is £12,570 (although yours may be lower if you have earnings above a certain level), so you only won’t need to pay income tax if your income is less than this amount. Find out more in our article How much tax will I pay on pension withdrawals?
Adam Garcia, finance expert from The Stock Dork said: “When you start drawing from your pension, be strategic about how much you withdraw each year. Keeping your withdrawals within the basic rate tax band can help minimise your tax liability.”
Take your pension tax-free cash gradually
Under current rules, you can usually take a 25% tax-free lump sum from your defined contribution pension once you reach the age of 55 (rising to 57 from 2028). Some pension schemes can have different rules, so ask your provider what age you can start taking retirement benefits from your pension. Find out more in our guide Should I take a tax-free lump sum from my pension?
However, you don’t have to take your tax-free lump sum all at once, and taking this money out gradually could help keep your tax bills to a minimum.
Dean Butler, Managing Director for Retail at Standard Life said: “In most cases, you can take it bit by bit if you’d prefer. This can be beneficial for a couple of reasons. Firstly, the longer you leave your pension savings invested, the more opportunity they have to grow, and so taking all of your tax-free lump sum at once could mean you get less in your pocket over the long term than you would if you took it in smaller chunks.
“Secondly, taking your tax-free lump sum in chunks over time is a tax-efficient way of taking your pension savings. As you’ll pay income tax on the rest of your savings, using your tax-free lump sum as a way to supplement the taxable part of your income could mean that you pay less tax overall.”
Make use of gifting allowances to reduce any potential inheritance tax liability
Inheritance tax might not be something you need to worry about now as it’s only payable when you die, but it could cause your loved ones a serious financial headache if you haven’t planned ahead.
Changes announced in the 2024 Budget could see thousands of UK households facing significantly higher tax bills, as the Chancellor unveiled plans to include pension savings in estates for tax purposes from 2027. According to Andy Wood from Tax Natives, these reforms could pull an additional 38,500 estates into the inheritance tax net, leaving families with an average bill of £34,000 unless they take action now.
Mr Wood said: “The proposed changes to inheritance tax could fundamentally alter the way families use pensions in their financial planning. Historically, pensions have been a vital tool for preserving wealth across generations, but the inclusion of pension assets in the inheritance tax net from 2027 could make them a significant tax liability. This is a huge departure from the current system and will impact thousands of families.
“These changes highlight the importance of looking for professional advice to understand the implications and take proactive steps. From making use of lifetime gifting allowances to restructuring wealth outside of pensions, there are options available to help families safeguard their financial legacies.”
You can learn more about current gifting allowances in our guide Which gifts are exempt from Inheritance Tax? and about the proposed changes in our article Budget 2024 pension changes.
A final thought…
Pension and tax planning can be complicated, and what’s right for one person might not be right for you. It’s therefore important to seek professional financial advice if you want to know the best ways to reduce any potential tax liability in retirement based on your individual circumstances.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
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