3 helpful ways to manage your increasing Income Tax bill in retirement

Category: News

There’s little doubt that 2022 was a turbulent year in the UK economy. The aftermath of the Covid-19 pandemic led to supply chain issues, inflation soared, interest rates rose, and a war in Ukraine contributed to rising energy costs. On top of this, we had four different chancellors in a single year.

One of the actions that the current chancellor, Jeremy Hunt, took was to extend the freeze on the Personal Allowance and Income Tax thresholds until 2028. The BBC reports that this will mean that 2.6 million more people will be caught in a higher tax bracket in the next five years.

What’s more, fiscal drag is seeing the number of over-65s paying Income Tax increase rapidly – MoneyAge reports that 8.5 million people aged 65 and over are now Income Tax payers, a 10% rise compared to the previous year.

The government hopes that their recent threshold freeze will raise nearly £30 billion in extra tax by 2028, but what does this mean for your tax bill and retirement plans? Read on to find out more.

Frozen thresholds are dragging more people into higher tax brackets

As mentioned, the number of pensioners paying Income Tax has increased in recent years.

Moreover, this could become increasingly common in the future. Steve Webb, the former Liberal Democrat pension minister, says: “The number of pensioners paying tax will continue to rise rapidly in years to come, particularly if inflation remains relatively high and thresholds continue to be frozen”.

The Personal Allowance is the amount you can typically earn before you start paying Income Tax, and this is frozen at £12,570 until 2028. Jeremy Hunt has also extended the freeze on the higher-rate threshold at £50,270 until the same time.

This means that, even though rates and thresholds haven’t changed, rising earnings mean that more people are being dragged into higher Income Tax rates across the board. It’s why threshold freezes are often referred to as a “stealth tax”.

Moreover, inflation has remained high in the past year, with the Office for National Statistics revealing that prices rose by 7.9% in the 12 months to June 2023.

When inflation is high, you may need to draw more from your pension to meet these rising costs. And, with these static Income Tax thresholds, this could mean that you end up in a higher tax bracket.

3 helpful ways to manage your Income Tax liability in retirement

Thankfully, there are some steps you can take, that can help you manage your Income Tax liability during retirement – read on to discover three ways to do so.

1. Regularly revisit your household spending

If you haven’t revisited your budget recently, there’s a chance you’re drawing more from your pension than is necessary to maintain a higher level of spending than is necessary. In this case, you could potentially be losing some of it to Income Tax.

It can be prudent to regularly assess your monthly spending to identify areas where you can make cuts. For instance, you may be spending money on a TV or gym subscription that you no longer use.

If you can reduce your pension drawings to below the higher-rate threshold then you’ll only pay 20% Income Tax, rather than losing 40% or more of your withdrawals.

2. Manage your pension withdrawals sustainably

Any money you withdraw from your retirement fund above your 25% tax-free lump sum is usually added to any other income you’ve received in the same tax year to work out how much Income Tax you owe.

Other sources that could contribute towards your Income Tax liability include:

  • Any State Pension payments when combined with other income you earn
  • Withdrawals from your private pension pot
  • Any income you earn from part-time work
  • Income from your final salary pension.

It may be worth creating a retirement income strategy that ensures you can draw your income from various sources tax-efficiently, as this could help you maintain your lifestyle while minimising the amount of Income Tax you pay.

Using drawdown can help you to carefully control the amount you withdraw in a given tax year. If you want to make a large purchase, splitting the withdrawal over two years, for example, could help you to remain below the higher-rate Income Tax threshold.

If you fail to manage your withdrawals carefully, you could potentially find yourself losing 40% or 45% of your drawings to Income Tax.

Additionally, you could also consider deferring your State Pension if drawing it would push you into a higher tax band. Your State Pension increases by the equivalent of 1% for every nine weeks you defer. This works out as just under 5.8% for every 52 weeks.

Doing this could mean you can start drawing the income at a later date – perhaps when your income needs diminish, and you don’t need to draw as much from your pensions.

Taking advice can be highly beneficial here. We can help you to create a retirement income strategy that ensures you can draw the amount you need to sustain your desired lifestyle in the most tax-efficient way.

3. Equalise your incomes as a couple

A joint income strategy during retirement could help you pay less tax as a couple on your retirement income, which could in turn allow you to take more of your pension.

For example, after you take your 25% tax-free lump sum, anything you draw from your pension is usually added to your other sources of retirement income and is taxed at your marginal rate.

Since you only pay higher-rate tax on retirement income above £50,271, you could draw £100,000 of income equally between you and your partner and you’ll only pay the basic rate of Income Tax.

Conversely, if you draw £70,000 and your partner takes £30,000, you’ll generally pay more Income Tax since you would pay higher-rate tax on a proportion of your earnings while your partner pays the basic rate.

This shows how financial planning can help you and your partner create a tax-efficient retirement income that allows you both to achieve your dream lifestyle after you stop working.

Get in touch

We can assist you with managing your Income Tax liability after you stop working.

Please email hello@globeifa.co.uk or call us on 020 8891 0711 to discuss how Globe IFA’s expert financial advisors can help you.

Please note

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.

This article is for information 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.