‘It’s not what you earn, it’s what you keep’

When you’re planning your retirement income, there are multiple factors to consider: how much you can expect from the State Pension, the value of the pensions you have accumulated in your working life, your projected outgoings and your potential later life expenses.

One more factor not to overlook is how much of your retirement income could you lose in taxes. The amount you pay to HM Revenue & Customs (HMRC) may be more than you expect, leaving you with less to cover your regular expenditure.

New data highlights that retired households lose nearly 14% of their income a year to direct taxes. Income tax and council tax take 13.9% off the average retired household’s pre-tax income of £31,674. Retirees are also impacted by around £4,078 a year in direct taxes[1].

Once you retire, you’ll no longer need to pay certain taxes, such as National Insurance. But other taxes are still applicable, including Income Tax. You’ll pay Income Tax on any taxable income you receive above your personal allowance (currently £12,570, tax year 2021/22).

Taxable income includes your State Pension (currently up to £9,339 if state pension age is after 5 April 2016), income withdrawn from your workplace or personal pensions, and income from other sources, such as part-time work or rental income from buy-to-let properties. There are also other taxes you might not have factored into your budget, such as Council Tax.

If you have different sources of income, you may end up with several tax codes, which tell your employer or pension provider how much tax to deduct. Don’t assume these are correct – HMRC does make mistakes. You should receive coding notices with details of your tax codes before the start of the tax year. It’s a good idea to check these are right and if you think there’s a mistake, or if you’re not sure, contact HMRC.

The first time you take a lump sum (apart from the tax-free lump sum) from a defined contribution pension scheme, it’s likely you’ll be charged too much tax. This is because most initial lump sum payments are taxed using an emergency tax code. This means you’re taxed as if you made the same lump sum withdrawal every month of the tax year. You can claim back overpaid tax.

The way your savings are taxed doesn’t change when you retire or reach State Pension age. Banks and building societies now pay savings interest without any tax taken off but, depending on your situation, you may still have to pay tax on some of your savings income.

An effective tax plan is a crucial part of planning for retirement and can help you make the most of your financial resources. It’s always important to consider the amount of after-tax income you’ll earn. Remember: ‘It’s not what you earn, it’s what you keep.’

Before you retire, there are various ways to boost your retirement income in the future. You may be able to increase the State Pension you’re entitled to claim by filling any gaps in your National Insurance contributions record.

If you haven’t taken advantage of them, you may have tax-efficient savings options, such as a Individual Savings Accounts (ISAs). Within an ISA you pay no UK tax on income or capital gains. Paying less tax could mean higher returns for you (and less work if you need to complete a tax return).

And you can also plan the most tax-efficient way to access your pension from age 55 (57 from 2028 unless your plan has a protected pension age). Taking money from your pension plan is a big decision, and when and how you do it can have significant impact on how long your savings will last. So, when the time comes, it’s important you feel confident you understand your options and how your decisions might affect the tax you pay and how long your money will last.

Defining your retirement goals and what you think you’ll require in terms of income can help shape your plan and how much you will need. To discuss your requirements, please contact us – we look forward to hearing from you.

[1] Key Equity Release 6 April 2021