When you retire, there are a lot of financial decisions that need to be made as you start accessing the savings and investments you’ve built up. It’s natural to have lots of questions about your financial security at this point, such as:

• How much income will I receive from my pension?
• How long will my savings last for?
• How should I access my pension?

But one important question is often overlooked: How much tax will I pay? 

How and when you access your pension, savings and investments can have an impact on your tax liability. Planning your retirement income with tax in mind can help reduce the amount of tax you pay, helping your savings go further. It should be one of the areas you consider as you approach retirement and that financial planning can help you understand with your circumstances in mind.

In some cases, it’s possible to create a tax-free retirement income or reduce liability greatly. So, what should you consider when assessing retirement income?

1. The Personal Allowance

The Personal Allowance is the amount of income you’re entitled to receive tax-free each year. For the 2020/21 tax year, the Personal Allowance is £12,500 for the majority of people. As a result, it’s important for planning your retirement income.

The Personal Allowance covers all forms of income, including your State Pension and income from investments, for example. Once you factor in all income sources in retirement, the total will likely exceed the Personal Allowance, but it provides a base for building a tax-efficient income. As the allowance resets with each tax year, spreading out or delaying taking an income at times can help you fully make use of the tax benefit.

It’s worth noting that if you’re married or in a civil partnership, the marriage allowance allows one person to transfer up to £1,250 of their Personal Allowance to their partner too.                                                                                                                                           

2. Pension withdrawal tax-free allowance

If you’ve been paying into a Defined Contribution pension during your working life, it will usually become accessible when you turn 55. This includes 25% available to withdraw tax-free. You can choose to take a 25% lump sum, tax-free, when you first access your pension, or you can spread the tax-free benefit over multiple withdrawals.

How and when you access your pension can have an impact on your income and lifestyle for the rest of your life. So, it’s important to understand the long-term impact of taking the tax-free lump sum.

3. Withdrawing from ISAs

ISAs (Individual Savings Accounts) offer a tax-efficient way to save and invest. Each tax year, adults can add up to £20,000 to ISAs, either contributing to a single account or spreading it over several. Through an ISA you can either save in cash, earning interest, or invest to hopefully deliver returns. The key benefit of ISAs is that interest or returns earned aren’t taxed.

As a result, you can make ISA withdrawals to supplement your pension income and other sources in retirement without increasing your tax liability.

4. Capital Gains Tax allowance

Selling certain assets for profit can result in Capital Gains Tax, this includes personal possessions worth more than £6,000 (excluding your car), a second home, and shares that aren’t held in an ISA or PEP (Personal Equity Plan).

However, there is an annual Capital Gains tax-free allowance, for individuals it is £12,300 (tax year 2020/2021). In retirement, this can be a useful way to increase your tax-free income. It’s important to understand your assets, their value and how they can create an income.

5. Dividend Allowance

If you’re invested in companies that pay a dividend, the Dividend Allowance can boost your income without affecting the amount of tax you need to pay. This is on top of any dividend income that falls within your Personal Allowance.

For the 2020/21 tax year, the dividend allowance is £2,000. Carefully planning your investments and expected dividend allowance can help you boost your retirement income by £2,000 without facing additional tax charges.

If your dividend income exceeds the allowance, you will need to pay tax. The tax rate is linked to your tax band and may be as high as 38.1% if you’re an additional rate taxpayer.

Depending on your circumstances and goals, there may be other allowances and reliefs you can take advantage of too. Using a combination of saving products, such as personal pensions, stocks and shares ISAs and general saving accounts, it may be possible to achieve the retirement income you want while reducing tax liability. Whether you’re nearing retirement or are already retired, it’s worth considering how much tax you’ll pay and whether there are allowances that apply to your situation.

Planning for taxation changes

While the above information is accurate for the moment, allowances, levels of taxation and reliefs do change. As a result, it’s important that your retirement plan and income are reviewed at regular points. This allows you to take advantage of any changes and adjust how and when you take your income if necessary. If you’d like to discuss your tax liability during retirement, please get in touch.

Please note: The Financial Conduct Authority does not regulate tax planning.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

Levels, bases of and reliefs from taxation may be subject to change and their value depends on individual circumstances.