A combination of stagnant tax thresholds and the upward trajectory of inflation is leading to a growing number of retirees having to take taxation into account. Continue reading to discover essential information about income tax liability during retirement and strategies to handle your tax responsibilities.
According to The Independent, in the 2023/24 fiscal year, approximately 8.5 million individuals aged over 65 are now subject to income tax. This reflects a substantial 10% increase compared to the previous year.
Typically, you will become liable for Income Tax when your income surpasses the Personal Allowance threshold. For the 2023/24 tax year, the Personal Allowance stands at £12,570.
In addition to bearing the Personal Allowance in mind, when you navigate the realm of tax responsibility, it is imperative to consider the thresholds that trigger higher or additional-rate income tax payments, which amount to £50,271 and £125,140, respectively, for the 2023/24 financial year.
Numerous factors contribute to the increased prevalence of income tax payments among individuals aged over 65, including:
1. Postponed Retirement Due to the Cost of Living Crisis: The past 18 months have witnessed significant inflation, placing considerable strain on household budgets. Consequently, some workers have deferred their retirement plans, leading to a higher number of over-65s remaining in the workforce and consequently paying income tax.
2. Inflation-Driven Income Increases: Escalating living costs, as exemplified by a 10.1% rise in the State Pension in April 2023 owing to inflation, or the potential for annuity income to grow annually, have propelled retiree incomes beyond the Personal Allowance threshold. This has resulted in many retirees finding themselves subject to income tax.
3. Frozen Income Tax Thresholds: Although retirement incomes may be on the rise, the government has chosen to freeze the Personal Allowance for the past three tax years, extending this freeze until 2027/28. This freeze has meant that despite increasing incomes, more retirees are now within the income tax bracket.
Should you discover that you are liable to pay income tax during retirement, there are potential measures you can explore to mitigate your tax liability.
Here are five practical measures to consider in order to reduce your income tax bill during retirement:
1. Leverage the Marriage Allowance: If you and your spouse or civil partner are planning for retirement, you may have the opportunity to utilize the Marriage Allowance. When neither you nor your partner fully utilize your Personal Allowance, you can transfer up to £1,260 of it between you. This transfer has the potential to decrease your combined income tax obligation by as much as £252 in the 2023/24 tax year. It’s important to note that the partner with the higher income must be a basic-rate taxpayer to take advantage of the Marriage Allowance.
2. Explore Other Tax Allowances to Enhance Your Income: Depending on your specific circumstances, there could be alternative avenues to increase your retirement income without triggering additional tax liabilities. For instance, if you have savings or investments held in an ISA, withdrawals from these accounts are not subject to income tax. Consequently, you might consider utilizing your ISA to supplement your income from other sources. Additionally, in the 2023/24 tax year, you have the opportunity to receive up to £1,000 in dividends from certain investments without incurring tax obligations.
3. Optimize Your Tax-Free Pension Cash Over Time: When you access your pension, it’s typically possible to withdraw up to 25% of your savings without incurring any tax liability. This tax-free cash can be received either as a lump sum or spread out through several withdrawals. By choosing to distribute this tax-free cash across multiple tax years, you may find opportunities to reduce your tax obligations, even in situations where your overall income surpasses the Personal Allowance threshold.
4. Effectively Manage Your Pension Withdrawals: If you decide to access your pension with flexibility, you have the autonomy to determine the amount you withdraw from your pension fund. You can adapt the income you receive based on your specific financial requirements. Consequently, you have the potential to adjust your pension withdrawals while taking your Income Tax liability into account. Lowering your withdrawal amounts could result in your entire income remaining below the Personal Allowance or higher-rate tax threshold.
5. Incorporate Tax Planning into Your Comprehensive Financial Strategy: To efficiently handle your tax responsibilities, it’s advisable to take a holistic view of all your assets. This approach can unveil strategies to utilize alternative income sources for funding your retirement while minimizing tax exposure. Integrating tax planning into your overall financial plan can enhance the benefits you derive from your retirement. We encourage you to reach out to us for a discussion regarding your retirement income and potential tax implications.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate tax planning.
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