Taxation and your retirement income
What tax could you pay on your retirement income, and what could the impact be on the money you have available?
Is my retirement income taxed?
Probably, yes. Most people will pay tax on the income they receive – though there are a few exceptions. So the decisions you make about how and when you do draw on that money, will impact the amount of tax you pay. There are three main options - we look briefly at how tax may affect each one.
Annuities and pensions
Income that you receive from annuities and pensions are taxed in the same way they would be if you were earning the money through a job – under the PAYE system. You can read more about different rates of tax and how much you have to pay for each band under 'What rate of tax will I pay?'
Again, you'll pay tax under the PAYE system on any income drawdown that you take. But as you can control how much income you take each year, you do have the flexibility to manage the tax you pay.
Tax-free lump sum
You can take up to 25% of your pension savings as a tax-free lump sum, but most people have to pay tax on any payments that they take after this.
Any ad hoc payments that you withdraw from your pension after the tax-free lump sum are treated as earned income, and taxed at your highest marginal rate. So, for example, if you had £50,000 in total in your pension, and withdrew all of it, you would have £12,500 tax free, and £37,500 would be taxable.
Take this example a step further - assume you have a salary of £20,000 - the £37,500 is added to this for tax purposes, which means you would be treated as earning £57,500 in the current tax year, which would push you into the 40% tax band.
So while it's appealing to take all of your pension savings in one go, you will pay tax at your marginal rate on the total amount (after any that's tax free) – which could be a significant amount.
If you are interested in finding out how much income tax you would need to pay if you took your whole pot in one go, our Pension Taxation Calculator could help. You can even print out your results afterwards if you wish - which may be helpful if you want to refer back to the illustrated figures later on.
What about my State Pension, is that taxed?
Yes – but it's paid to you gross (before any tax is deducted). However, if you also receive other income (e.g. from private pensions or earnings), your employer/pension provider will deduct income tax through the PAYE system. They will also deduct tax due on your State Pension.
What about other income?
If you receive income from any other sources – such as from continuing to work, or receiving rental income, you may need to pay income tax at your highest marginal rate.
And is there any income I definitely won’t pay tax on?
The rules may change in the future, but at the moment you won’t pay additional tax on certain types of income in retirement, including:
- Pension Credit
- Winter Fuel Payments
- Attendance Allowance
- Disability Living Allowance
- War Widow’s or Widower's pension
- Individual Savings Accounts (ISAs)
- Some National Savings and Investments products
The amount of tax you have to pay on any income you receive during your retirement depends on two factors:
1. the level of Personal Allowance that you receive from the Government (the amount of money that you can receive before you have to pay tax), and
2. how much income you receive.
The Government will write to you to let you know what your personal tax allowance is. Usually this will happen before the start of each new tax year on 6 April.
Any income that you receive over this amount will be taxed depending on how much you earn. There are currently four tax bands which can be explained using the table below:
|UK PAYE tax rates and thresholds (excluding Scotland)|
|UK personal allowance||Up to £12,500||0%|
|UK basic rate||£12,501 to £50,000||20%|
|UK higher rate||£50,001 to £150,000||40%|
|UK additional rate||Over £150,000||45%|
|Scotland PAYE tax rates and thresholds|
|Scottish personal allowance||Up to £12,500||0%|
|Scottish starter tax rate||£12,501 to £14,585||19%|
|Scottish basic tax rate||£14,585 to £25,128||20%|
|Scottish intermediate tax rate||£25,159 to £43,430||21%|
|Scottish higher tax rate||£43,431 to £150,000||41%|
|Scottish top tax rate||Over £150,000||46%|
Are there any exceptions to this?
Yes, there are a few circumstances which might mean your Personal Allowance is different.
If you are blind you may be given a Blind Person's Allowance. If you are eligible, this adds a further £2,500 to your yearly tax-free Personal Allowance.
Also, if you are married, or in a civil partnership you may be entitled to transfer up to £1,250 of your Personal Allowance to your partner under the Marriage Allowance. To qualify you will need to earn less than them though, and your income must be less than £12,500 per year. Please note that these are figures for the 2020/21 tax year.
Your Personal Allowance will also be less than the amount quoted above if your adjusted net income is over £100,000. Your adjusted net income is your total taxable income before any Personal Allowances, less certain tax reliefs.
These are just some examples, but you can read more about your Personal Allowance and the different tax bands on the Gov.uk website.
Who do I pay the tax to?
If you live in the England, Wales and Northern Ireland you will pay your income tax to the UK Government who use the money to fund their spending across these areas. However, if you live in Scotland then from April 2017 your income tax will be collected by HMRC and paid to the Scottish Government.
What else should I think about?
It’s a good idea to just remember when you’re setting retirement goals or budgeting for the future, that you're likely to pay tax on your income. A drop in the figures you’re using is likely to have an impact on the plans you’re trying to make.
If you would like to explore your personal situation in detail, the best thing to do is to speak a qualified professional. You can search for a local financial adviser at thepfs.org or Unbiased.co.uk.