While your clients may draw from their workplace or private pensions to fund their lifestyle in retirement, their State Pension offers a useful supplement to their income.
One of the key benefits of the State Pension is that your clients receive the payments for the rest of their life once they turn 66 (there is a phased increase to 67 and eventually 68 for those born after 5 April 1960).
Additionally, the payments normally increase every year because of a guarantee called the “triple lock”.
The triple lock ensures that every April, the State Pension payments rise by the highest of:
- The rate of inflation
- Average wage growth between May and July the previous year
- 2.5%.
While this may be good news for your clients as they receive a higher income, it could also mean they’re more likely to pay tax in retirement.
Indeed, FTAdviser reports that, in 2024, 140,000 pensioners are expected to receive their first tax demand since retiring.
Read on to learn why this is and three ways a financial planner could help clients reduce their tax bill in retirement.
“Fiscal drag” could mean that your clients are more likely to pay tax in retirement
One reason that your clients may be more likely to pay tax in retirement is that they could be affected by “fiscal drag”.
This describes a situation where certain tax thresholds are frozen, while your clients’ income increases. As a result, a higher percentage of their income exceeds the thresholds and they pay more tax.
For example, Income Tax thresholds have been frozen at their current levels since April 2021 and will remain so until at least 2028.
In comparison, Royal London reports that the new State Pension payment increased from £179.60 a week in April 2021 to £221.20 a week in April 2024.
In fact, the annual new State Pension payment is £11,502.40 in the 2024/25 tax year. Meanwhile, the “Personal Allowance” – the amount of income an individual can receive without paying Income Tax – is £12,570.
As such, the State Pension could use most of the Personal Allowance. This means that your clients are more likely to pay tax when drawing additional income from their private or workplace pensions.
Additionally, if living costs rise, as they have been over the past few years, your clients may need to draw a higher income from their pensions to fund their lifestyles.
This is why more pensioners are expected to pay Income Tax in the future. Fortunately, there are three ways we could help your clients mitigate a large tax bill.
1. We’ll create a detailed retirement budget to help your clients draw sustainably from their savings
If your clients can limit the income they draw from their pensions, they may be able to avoid exceeding their Personal Allowance. Alternatively, if they do exceed the threshold, they could remain in a lower tax band by managing their income carefully.
To achieve this, we can help clients create a detailed retirement budget that outlines all their expenses. This may include spending on:
- Utility bills
- Groceries
- Social activities
- Travel
- Financially supporting loved ones.
Using this budget, we can determine how much they need to draw from their pensions to fund their lifestyle. As a result, they only take what they need, meaning they could reduce the Income Tax they pay.
2. We can show your clients how to make strategic use of their tax-free lump sum
Your clients can typically draw the first 25% of their defined contribution (DC) pensions tax-free – up to the “Lump Sum Allowance” (LSA), which is £268,275 in 2024/25.
They will pay tax on any portion of their 25% lump sum that exceeds the LSA. Additionally, any income they draw from the remaining 75% of their pensions may be taxed if it exceeds their Personal Allowance.
Normally, they’re able to take the tax-free portion of their pension as a lump sum or in several instalments. Also, they can draw from the taxable and tax-free portion of their pensions at the same time.
We can help your clients make strategic use of their tax-free lump sum and spread it out. This could mean that they’re able to keep their taxable income under the Personal Allowance and won’t pay Income Tax.
For example, if they draw £1,000 a month from the tax-free 25% and another £1,000 from the remaining 75% of the pension, they’ll have an income of £2,000 a month. However, only £12,000 of that is taken from the taxable portion of their pension, so this alone won’t exceed their Personal Allowance.
3. We will explore savings from other sources that could help clients reduce their tax bill
As well as their pensions, your clients may have other savings, such as those in an ISA. Wealth in an ISA is typically tax-free, so they may want to use these savings to fund their lifestyles before accessing their pensions.
Alternatively, they might take a portion from their pensions and then top it up with ISA savings, meaning they reduce the amount of taxable income they draw each year.
We can discuss the most tax-efficient ways for your clients to draw from their other savings while also making strategic use of their tax-free lump sum. This could mean they’re able to fund their desired lifestyle while also reducing their tax bill.
Get in touch
If your clients are concerned about the tax they may pay in retirement, we can help.
They can contact us at hello@ardentuk.com or call or WhatsApp us on 01904 655 330. As an award-winning financial advice company with advisers included in the 2024 VouchedFor Top Rated guide, you can be sure that we’re a bona fide company providing excellent advice and high-quality service.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients 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.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation, and regulation, which are subject to change in the future.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
