How to reduce tax liability to make your retirement income go further

Retirement planning means making a lot of decisions. You may already have thought about how long your pension needs to last or how other assets can provide an income. But have you considered tax liability?

Making the most of allowances in retirement can help your pension savings and other assets go further. Financial planning can help reduce tax liability throughout retirement and add up to significant savings. It could mean your retirement is more comfortable and you’re able to enjoy more of the things you’ve been looking forward.

Understanding what income you need

The first step to reducing tax liability is to understand the level of income you need to achieve your goals.

Often, retirees find they need less income in retirement than they did when working, despite maintaining the same lifestyle. This is because some areas of expenditure, like travelling to work, are removed. You may find that your income needs change throughout retirement too. For example, you may spend more in the early years as you enjoy your new-found freedom before settling into a more laidback retirement lifestyle.

There’s no right way to retire or how to spend your time. Thinking about the lifestyle you hope to have, and reviewing this regularly, can help ensure your income matches your needs.

Why is this important? Because income you receive may be taxed, this may include withdrawals from pensions.

Taking more than you need out of pensions may mean your tax bill is unnecessarily increased, especially if you exceed certain allowances. Instead, spreading withdrawals to suit your income needs can reduce tax liability.

When it comes to pensions, you should also consider what you’d do with the excess you withdraw. The chances are it would sit in your current account or savings account earning little interest. In many cases, leaving the money in a pension where it’s invested can yield higher returns over the long term.

6 allowances to keep in mind

Tax-efficient allowances can help you reduce tax liability in retirement. Here are six you should consider when creating a financial plan.

1. Pension commencement lump sum

Once you reach pension age, normally you’re able to take up to 25% of your pension tax-free. At the moment this is available from age 55, rising to 57 in 2028.

If you have some big-ticket expenses as you start retirement, this tax-free lump sum can be incredibly useful. You may want to use it to travel more in the next few years or pay off remaining mortgage debt before you enter retirement. You need to be careful that you do not accidentally exceed this amount. Pension withdrawals are considered income for tax purposes. As a result, you could face an unexpected tax bill if you withdraw more than 25%.

You should also weigh up the long-term consequences of taking a large lump sum from your pension before proceeding. It could mean you run out of savings during your lifetime.

2. Personal Allowance

The Personal Allowance is the amount a person can earn each tax year without paying Income Tax. For the current tax year (2020/2021), the Personal Allowance is £12,500. If your entire income is below this threshold, no Income Tax is due. As a result, you should keep track of all forms of income you receive, including pension withdrawals, the State Pension, salary from paid positions and income from investments.

In some cases, spreading out income across several tax years can help reduce Income Tax liability.

You should also be aware of the Income Tax bands. For example, receiving an income of more than £50,001 in total can suddenly mean a pension withdrawal is taxed at the higher rate (40%) rather than the basic rate (20%).

3. Marriage Allowance

If you’re married or in a civil partnership, it’s worth checking to see if you’re able to take advantage of the Marriage Allowance. This allows someone to transfer £1,250 of their Personal Allowance to their husband, wife or civil partner each year. It’s a step that can reduce their tax by up to £250 annually.

4. ISAs

Each tax year you can place up to £20,000 into ISAs. Whether you choose to save or invest through an ISA, your money can grow tax-efficiently. When you make a withdrawal, including any interest or returns, no tax is due.

As a result, if you have money in ISAs, they can be a useful way to supplement other sources of income without increasing your tax liability. However, keep in mind that you won’t be able to contribute more than the £20,000 to ISAs a year in most cases even if you withdraw a higher sum.

5. Capital Gains Tax allowance

Capital Gains Tax is a tax paid on the profit when you sell or dispose of certain assets. This may include property that isn’t your main home and shares that aren’t held in a tax-efficient wrapper like an ISA. However, each year you have a Capital Gains Tax allowance. For the 2020/21 tax year, this is £12,300 per individual. Staying below this threshold when disposing of assets can help reduce the amount of tax you pay. As a result, waiting until a new tax year to sell some assets could make sense financially.

In some cases, it can also make sense to transfer assets to a spouse to make full use of their Capital Gains Tax allowance too.

6. Dividend allowance

Investing in companies that pay a dividend is also an option for adding to your income without increasing tax liability. The current dividend allowance is £2,000, which could boost your income without having to pay additional tax. However, you will need to carefully manage your investments to ensure you don’t exceed this amount or you could face an unexpected tax bill.

Please keep in mind that allowances and tax rates are likely to change. It is important to make sure you have the latest information when making financial decisions. This is a step we can help you with. Please contact us if you’d like to speak to a financial planner about your retirement plans, including tax liability, or review existing plans.

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment. The value of your investments (and any income from them)  can go down as well as up and you may not get back the full amount you invested., 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.

Levels, bases of and reliefs from taxation along with 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.


The Financial Conduct Authority does not regulate tax advice.

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