Published On: Sat, Jul 30th, 2022

State pension and tax: ‘Seek advice early’ to avoid being hit by income tax | Personal Finance | Finance


After paying into the system for so many years, people will naturally want to avoid having to pay even more back in tax. But the state pension is subject to income tax, along with any other earnings and pensions a person receives, so it’s worth knowing what can be done to minimise one’s tax bill.

Express.co.uk has spoken to several finance experts about the various ways people can arrange their finances for their later years.

The state pension is paid gross, without tax deducted, usually every four weeks into a person’s bank account.

The full basic state pension is currently £141.85 a week.

Men born on or after April 6, 1951 and women born on or after April 6, 1953 get the new state pension instead, while the full new state pension is £185.15 per week.

If this is all a person receives for their income, they will likely be below the personal allowance with no tax to pay.

But those who are still working or getting an income from investment, rental property or other pensions pots will have to pay income tax on anything above their Personal Allowance.

Claire Trott, divisional director of retirement and holistic planning at wealth management firm St James’s Place, explained how the tax bill is worked out.

She said: “If the only other income received is through either an employment or another pension, then the tax will be taken account of through these payments under the Pay As You Earn (PAYE) process run by those making the other payments.

“This will mean that the tax code applied takes account of the payments made of the state pension, effectively reducing the personal allowance available on these payments.

“If other income is being received through investments or property rental, then the state pension as well as any other income will need to be declared during self-assessment to be sure that the correct amount of tax is paid each year.”

Fortunately there are ways to arrange a person’s income so they don’t need to pay tax.

Ms Trott said: “You need to pay all your tax due, but how you access your income or where you invest can make a difference to what is payable.

“This is just the same for those working as for those taking state pensions. There are no special rules here for those over the state pension age.

“For instance, with property rental it is imperative that allowable expenses incurred as part of the rental are declared on the self-assessment, legitimately reducing the income tax payable.

“The structure of investments made before retirement can give greater access to income without the need to pay tax, such as ISAs which are tax-free to draw from.

“Other allowances can be used each year provided assets are in the right place, depending on your total income you can receive the first £5,000 of saving interest tax-free (savings starting rate) and up to £1,000 of personal savings allowance.”

The allowances decrease as a person’s income increases.

Funds can also be received by selling off assets, although in this case people should be aware of the capital gains tax.

As long as the asset has not grown in value by £12,300 or more, there will be no capital gains tax to pay.

Ms Trott said: “This does not mean that assets should be sold each year, but careful planning of sales can make sure this allowance is used appropriately.

“Making charitable gifts may also reduce the amount of tax you have to pay overall.”

Another option to reduce a person’s tax bill is to transfer part of a personal allowance to a husband, wife or civil partner.

Marriage Allowance allows individuals to move £1,260 of their personal allowance to a partner, reducing the recipient’s tax bill by up to £252 a year, meaning as a couple they pay less tax.

If a partner in the marriage or civil partnership was born before April 6, 1935, they may be able to access the Married Couples Allowance, which could save even more, up to £941 per tax year.

The saving can be shared between partners if one is not paying enough tax to benefit.

Ms Trott urged people to plan ahead given the various ways they can arrange their income to avoid tax.

She said: “There are many moving parts, all of which can add up to significant legitimate savings of tax in the long run.

“It is important to plan with regards to savings and investments to ensure that funds are held in the most tax efficient vehicle and the correct spread is achieved.

“So when it comes to accessing the funds eventually these savings are not eroded by unnecessary tax payable.”

Michael Lapham, director of financial planning at accountancy group Mercer & Hole, said it is vital people plan ahead for their later years – with some even putting money aside for the next generation’s retirement.

He said: “It is important to seek advice early and the earlier the better.

“For most individuals this means as soon as they start earning but given the tax efficiencies of pension contributions it has become more common in recent years for other family members, typically parents or grandparents to pay into pensions for children and non-working adults.

“The key is that the longer the period of time that the money is invested for the more chance it has to benefit from investment growth.”

He recommended looking at a pension product which includes a flexi-access drawdown, providing flexibility to work around the available tax bands.

He said: “The value of your pension is unlikely to be subject to inheritance tax on your death, so if possible you should use other sources of funds and only access your pension as a last resort.”

Research from Kreston Reeves Financial Planning recently found that only 36 percent of people aged 35 to 59, and 32 percent of those aged over 60, believe they have enough in their pensions to fund the retirement they want.

Kim Williams, financial planning director at the group, said: “Pensions may offer many advantages for saving towards retirement, including the benefit of tax relief at your highest marginal rate on personal contributions which, dependent on the type of policy, tax relief method used and own personal circumstances, is either claimed by the pension provider themselves, or in the case of salary sacrifice/exchange used for workplace pension policies, added immediately.

“Any growth in the value of the UK pension is free from UK income tax and capital gains tax.

“As long as it remains invested inside the pension wrapper.

“Overseas investments or non-UK registered pension schemes will have a different tax treatment depending on your circumstances.”



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