Your tax allowances in retirement explained

What tax might I have to pay in retirement?

There are a lot of changes to deal with as you transition from your working life to retirement and this includes your tax allowances. Your income, including your pension, is still taxable in retirement, but there are allowances which can make a big difference.

Find out how different potential incomes in retirement are taxed with this handy guide, as we discuss the following:

• Income Tax and National Insurance contributions
• Tax on workplace or personal pensions
• Tax on savings
• Tax on equity release income
• Tax on income from multiple sources

Please note: This article is provided for information purposes only and does not represent financial, mortgage, investment or tax advice. If in doubt, you should seek independent financial advice.

Income Tax and National Insurance contributions

After you retire you will still have to pay Income Tax on any income you receive over your personal allowance, which is £12,570 for 2023-24. If you earn or receive less than this, you will not pay tax.

Some people assume that their pension income – especially the State Pension – is tax-free, but that sadly isn’t the case.

Although tax isn’t taken from your State Pension, it is classed as taxable income and will use up a large amount of your personal allowance. So in 2023/24, if you receive the full new State Pension (£10,600.20), you will have £1,969.80 left of your £12,570 personal allowance. You can use this for any other taxable income such as your job or a private or occupational pension.

You can read more about paying tax on your State Pension on the MoneyHelper website.

Once you reach State Pension age then you no longer have to make National Insurance contributions, even if you continue working beyond the State Pension age.

Tax on workplace or personal pensions

Employees are now typically automatically enrolled into their employer’s pension scheme. Both you and your employer contribute to the scheme, and the government boosts your contributions through tax relief. Employees can however opt out if they wish. You may also have been paying into your own personal pension as a way to build up a pension fund for access in retirement.

The two different types of pensions are defined contribution (DC) and defined benefit (DB) schemes. 

Tax on defined contribution pension income

Once you are 55 (increasing to 57 from 2028), you can access the money in your defined contribution (DC) pension fund as and when you want.

The first 25 per cent of your pension fund can be taken tax-free. Typically you would take a quarter of your pot in a single tax-free lump sum, or you can take smaller amounts with 25 per cent of each being tax-free. The rest of your pension income, from an annuity for example, is taxed in the normal way.

Tax on defined benefit pension income

A defined benefit (DB) pension – also known as a final salary or career average pension – pays you a guaranteed income for life. You may be able to take a tax-free lump sum from your DB pension scheme, although how much this is will be determined by the scheme’s rules. Income from the scheme once you have taken any tax-free lump sum is taxed in the normal way.

Tax on your savings

There is a separate tax allowance for savings called the Personal Savings Allowance. This determines the amount of tax-free interest that you can receive on your savings in one year.

Currently the limit is £1,000 for basic rate taxpayers and £500 for higher rate taxpayers. 

If your income falls below £17,570 then you may also get up to £5,000 of interest and not have to pay tax on it. This is your starting rate for savings. This is in addition to the £1,000 Personal Savings Allowance.

Any interest you get from tax-efficient savings accounts, such as cash ISAs, is tax-free. 

Tax on equity release income

You do not have to pay tax on the money you receive from equity release. It is the same whether you arrange a lifetime mortgage or a home reversion plan. The cash lump sum or income you receive from your plan will be free from income tax and capital gains tax.

However, if you were to move your equity release money into a savings account while you decide how to spend it, there may be tax implications. This is because interest that you earn on savings can be subject to tax (see point above).

Your equity release adviser will be able to provide more information on this and other pitfalls to equity release during your appointment. Depending on your situation, they may recommend you seek specialist tax advice before arranging a plan. You can read more about tax on equity release.

If a tax-free cash lump sum would help you in retirement then do get in touch with our selected equity release advisers. Our selected advisers will take the time to explain everything to you in a jargon-free way. Call 0808 178 3055 or request a free callback here to arrange an appointment.

Tax on income from multiple sources

It’s common to have incomes from multiple sources in later life. You may choose to continue working past State Pension age, so receive a working income and a pension at the same time. Or you might retire but have an income from property or investments.

Remember, if you are still earning money while drawing your pension then your tax bill will increase. If you receive an income from more than one source, you’ll need to let HMRC know to ensure you pay the right amount of tax. 

So how will tax be taken from your multiple incomes? Typically, your personal allowance will be allocated against your main job or pension, usually the one that is more than your personal allowance. Then, any other income is taxed in the normal way 

If you receive an income from property or investments, continue to work as self-employed or your total income is £100,000 or more in a tax year, then you’ll have to fill in a Self-Assessment tax return.

Where to get further help with tax queries

If you have queries about the tax you pay or want some free advice on tax issues then there are some helpful organisations you can go to if you’re on a low income. These include:

• TaxAid provides free, independent advice on tax issues for those with incomes of £20,000 a year or less.
• Tax Help for Older People provides free tax help and advice to older people who are on lower incomes of £20,000 or less.

About Clare Yates. With over a decade’s experience writing about later life financial planning, Clare offers a wealth of knowledge about equity release, pension annuities, wills, LPAs and more. When she isn’t writing, Clare likes to spend her time baking and going on walks with her husband, two children and their rescue dog. Follow Clare on LinkedIn