One of the most powerful ways to boost your income and capital in retirement, and to increase the amounts you can leave to your family, is to keep the amount of tax you pay to a minimum.
Your approach to tax saving in retirement needs to be quite different to the approach you used when you were working.
During your working life, you’ll have been encouraged to pay money into tax-efficient savings schemes like pensions and ISAs, and the providers of these schemes will have marketed and sold them to you.
But retirement is the time you start to spend the money you have saved and the same providers aren’t keen to encourage you to spend the money you have invested with them.
It’s no coincidence that providers usually get paid a percentage of the value of your savings!
So you need to do things differently to save tax.
The best thing you can do is to put a plan in place and then to implement it.
If you make a mistake in retirement, you may not be able to correct it – for example, once you start receiving the state pension, you can’t stop it. So planning is essential.
Our approach is to include the tax strategy as part of your retirement income plan.
Your income and capital will be shared between you and the taxman once you’ve stopped work, and it’s got to be a good thing if you keep more of it and the taxman gets less.
For some people, good tax planning can make the difference between a happy and miserable retirement.
So, here are a few simple ways to plan to save tax:
The one year income holiday
Many people can avoid paying income tax altogether for a tax year by taking a few simple steps.
So, your first year of retirement could be funded using some of your tax-free lump sum from an investment-linked pension or by drawing down on ISAs.
You may need to defer your state pension, and put off drawing a company pension or annuity in order to ensure you don’t pay any income tax for the year.
As well as paying no income tax, the tax-free year brings additional benefits
• it allows you to take out money from other investments, like investment bonds, without paying tax
• if you hold investments which have made capital gains, you can cash them in and pay less capital gains tax than you would otherwise do.
• If you still have a company, you can pay yourself a special dividend and pay no tax. You could pay yourself a dividend of up to £16,000 and pay no income tax at all.
• You will reduce the amount of tax you pay on interest you receive (from deposits, corporate bond funds and loans you have made).
Most people can only do this if they aren’t in receipt of the state pension, a company pension or annuity.
Investment-linked, drawdown pension income payments can be stopped once they have started but other types of pension payments can’t be.
“Failing to plan” really can mean “planning to fail”.
Spend your ISAs
It’s almost as if ISAs were designed to be spent in retirement.
You can take income or capital out of them at any time, and you pay no tax. But when you die, they form part of your estate and are subject to inheritance tax.
So, it makes sense to draw them down in your lifetime until they are exhausted (don’t forget to leave yourself some money for emergencies though).
Plan Your Pension Withdrawals Carefully
If you thought pensions were complicated when you were saving money for your retirement, you’ll be pleased to know that they are just as complicated once you’ve stopped work.
If you get things wrong, you’ll end up giving more of your hard-earned money to the taxman and keeping less for yourself.
The best approach is to imagine that your investment linked pension is made up of two, quite separate parts – one part which you can withdraw without paying tax (this usually starts out at 25% of the total value) and another part from which withdrawals are taxed.
Then remember that:
• You don’t have to take out all of the tax free part in one go. You can stagger the payments, taking out enough to fund the coming year’s spending, for example.
• If you take out all of your tax free lump sum in one go, and don’t spend it, you may will have turned something tax free into something taxable. The taxman will be delighted!
• For the taxable part, you can use your personal allowance for income tax – whilst the withdrawals might be taxable, you don’t pay tax on the first £11,850 of income (this tax year).
• On your death, any remaining pension fund is exempt from inheritance tax.
• You don’t pay tax on the investment returns which you make in your pension
So, if you can afford to do so, it makes sense to use the tax free lump sum to fund your annual expenditure at first, and then to keep the withdrawals from the taxable part low…. as long as current rules continue to apply.
But, of course, politicians love to tinker with pension rules, and it’s been a few years now since the rules were changed, so you’ll need to monitor pension rules; this is the sort of thing I like doing, but I’m told that other people don’t!
In retirement, tax planning means the taxman gets less and you get more to spend on the good things in life.
But the rules continuously change and it isn’t the most fascinating hobby – so get someone like me to do it for you!
You can make your retirement less taxing with these simple financial planning steps Share on X