A guide to tax in retirement
Retirement brings with it a lot of change: change to your routine, to your income and changes to the amount of tax you have to pay. Find out how your pensions are taxed and when interest on your savings may be paid tax free.
Income Tax and National Insurance contributions
You still have to pay Income Tax after you’ve retired. This applies to all your pension income, including the State Pension. Many people assume that their pension income – especially the State Pension - will be tax free, but that’s not the case.
Some income, including your State Pension, is paid without any tax being taken off. But if tax is due, this will often be collected by taking money off any company pension payments or when you take money out of a workplace or personal pension.
Income Tax personal allowances
You are able to earn or receive up to £11,000 in 2016-17 tax year (April 6th to April 5th the next year) and not pay any tax. This is called your Personal Allowance. If you earn or receive less than this then you are a non-taxpayer.
The Personal Allowance is increasing to £11,500 in the 2017-18 tax year.
Also, from 6 April 2016, the age-related allowance will no longer exist.
How your pension is taxed
The basic principle is that you can take 25% out of your pension pot tax free. The remaining pot is used to provide an income or can also be withdrawn; in both cases this is taxable. That means any money you receive over your Personal Allowance will be taxed.
Defined benefit pensions
If you have a defined benefit pension (also known as a final salary or career average pension) you can take up to 25% of your pension tax free, but you will be paid the rest as an income, which will be taxable.
Defined contribution pensions
From April you may be able to take as much money out of your pension as you want. However, only the first 25% will be tax free and the rest is taxable. That means, the more money you take out, the higher your tax bill could be.
For example, if you have a £100,000 pension and take all of the money out in one go, one quarter (25%) or £25,000, will be tax free. The other £75,000 will be taxable. You won’t necessarily have to pay tax on the whole £75,000 as you have your Personal Allowance (as described earlier). However, you could still have a lot of tax to pay. Your pension money will normally be paid with the tax deducted.
Understanding your tax codes
When you retire, if you receive an income from several different sources; for example, more than one pension, savings income and earnings from a job, you may be given more than one tax code. Make sure you check the tax code(s) so you know the right amount of tax is deducted.
If you aren’t sure whether your tax code is correct, the charity the Low Incomes Tax Reform Group has information about Checking your tax code.
Tax-free interest on your savings
The introduction of the new Personal Savings allowance in April 2016, means that taxpayers on the basic rate will not have to pay tax on their first £1,000 of savings income. And people on the higher rate won’t have to pay tax on their first £500 of savings income.
If you previously completed the R85 form to receive interest without the tax taken off, you will no longer be able to do so from April 2016. The option to receive your interest tax-free is no longer available. This is because from April 2016, banks and building societies will no longer deduct basic rate tax from the interest on your savings.
You can still however claim back tax you may have paid on your savings in previous years when you should not have done. Use form R40 to do this.
Interest you receive from tax-efficient savings accounts, such as cash ISAs, is paid tax free whether or not you’re a taxpayer.
National Insurance contributions
If you continue working beyond the State Pension age, you no longer pay National Insurance contributions on your earnings.