POT LUCK
Three ways to combat Labour’s ‘retirement tax’ set to affect 8million pensioners
Read on to find out how you can avoid paying tax on your pension
MILLIONS of pensioners will see their income hit by Labour's 'retirement tax', but there are ways to minimise the impact on your finances.
Earlier this week The Sun exclusively revealed 8.2million people over the age of 60 will be dragged into paying income tax by 2027/28.
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The government's decision to continue the freeze on tax thresholds, coupled with high inflation, will cause millions of households to start paying income tax in the next three years.
Data provided by HMRC through a freedom of information (FOI) request made by wealth manager Quilter and shared exclusively with The Sun, showed nearly 18million people will be forced to pay income tax.
Of those, 8.2million will be over the age of 60 and paying tax on their retirement income for the first time.
Tax thresholds usually increase every year in line with increases in the state pension and wages.
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This ensures that workers and pensioners are not worse off in real terms.
But in April 2021, the then-Conservative government froze all tax thresholds until 2028.
The freeze means many people will be forced to pay tax for the first time or will pay it at a higher rate.
The state pension increases every year in line with inflation, 2.5 per cent or wage growth - whichever is highest.
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But inflation has soared in the past couple of years, so the state pension has increased by more than usual to keep up with rising costs.
As the tax thresholds have not moved, this means pensioners may need to pay tax on their payments or pay it at a higher rate.
What are the different types of pensions?
Originally, the government predicted that around 1.3million people would be dragged into paying income tax, with a further 1million people paying at the higher rate.
But the latest figures show this has leapt up to almost 30million people affected in total.
Around 18million will start to pay tax - 8.2million of who will be pensioners.
But, there are ways those in their retirement can minimise the impact of the increase.
What are the different types of pensions?
WE round-up the main types of pension and how they differ:
- Personal pension or self-invested personal pension (SIPP) - This is probably the most flexible type of pension as you can choose your own provider and how much you invest.
- Workplace pension - The Government has made it compulsory for employers to automatically enrol you in your workplace pension unless you opt out.
These so-called defined contribution (DC) pensions are usually chosen by your employer and you won't be able to change it. Minimum contributions are 8%, with employees paying 5% (1% in tax relief) and employers contributing 3%. - Final salary pension - This is also a workplace pension but here, what you get in retirement is decided based on your salary, and you'll be paid a set amount each year upon retiring. It's often referred to as a gold-plated pension or a defined benefit (DB) pension. But they're not typically offered by employers anymore.
- New state pension - This is what the state pays to those who reach state pension age after April 6 2016. The maximum payout is £203.85 a week and you'll need 35 years of National Insurance contributions to get this. You also need at least ten years' worth to qualify for anything at all.
- Basic state pension - If you reach the state pension age on or before April 2016, you'll get the basic state pension. The full amount is £156.20 per week and you'll need 30 years of National Insurance contributions to get this. If you have the basic state pension you may also get a top-up from what's known as the additional or second state pension. Those who have built up National Insurance contributions under both the basic and new state pensions will get a combination of both schemes.
Laura Suter, director of personal finance at AJ Bell, and Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, share their tips.
Consider putting your savings into an ISA
An individual savings account (ISA) is a type of tax-free savings account.
You can pay in up to £20,000 each year and earn interest on your nest egg.
It can be a good option if you have a lot of cash savings, for example if you have inherited some money or sold a house.
This is because you do not need to pay tax on any of the interest you earn.
Meanwhile, if you paid the same sum into a savings account you may have to pay tax depending on how much you earn in interest.
If you are a basic-rate taxpayer then you can earn up to £1,000 in interest each year without needing to pay tax.
But if you are a higher rate taxpayer then your allowance drops to just £500.
Meanwhile, if you are lucky enough to be an additional rate taxpayer then you cannot earn any interest on your savings without paying tax.
If you decided to pay the same lump sum into a private pension then you may need to pay tax to withdraw it again.
This is because you can can usually only withdraw 25% from your pension as a tax-free lump sum.
After that you can earn up to £12,570 a year as income before you need to pay tax.
Money you get from the state pension, your private pension and any benefits are all considered as income.
But by keeping your money in an Isa, rather than a private pension, you can access your cash tax-free.
Laura Suter explained using an example of someone withdrawing 4% a year from a £100,000 ISA pot.
This would give you an income of £4,000 a year that you do not need to pay tax on.
Laura said: "Pensioners looking to reduce their tax bill need to think about how they can maximise their tax-free income.
"For example, any withdrawals made from their ISAs will be free of any tax, so they can use that pot of money to boost their income without impacting their tax bill."
Make the most of your other pensions
It's tempting to take out your whole private or workplace pension when you reach retirement and put it into a savings account.
But if you do this you could end up paying income tax and tax on any interest you earn.
Instead, think about withdrawing your 25% tax-free lump sum.
You can either do this all in one go or in smaller gradual amounts to top up your state pension without being taxed on it.
Laura said: "You can take ad-hoc amounts or regular withdrawals from the pot to use your tax-free amount gradually.
"This is a great way of boosting your income but not increasing your tax bill."
Marriage Allowance
If you are married or in a civil partnership you might be able to reduce the amount of tax you pay overall via the Marriage Allowance.
It lets you transfer some of your personal allowance to a spouse if you do not pay tax on your income and they are a basic-rate taxpayer.
To be eligible you must earn less than £12,570 and they must have an income of between £12,571 and £50,270.
Marriage Allowance for this current tax year is worth £252.
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Helen Morrissey, from Hargreaves Lansdown, said: "The non-taxpaying partner can transfer £1,260 of their Personal Allowance to their partner.
"This reduces their own personal allowance so it might mean they end up paying some tax but the boost to the taxpaying spouse means you pay less tax overall as a couple."
How does the state pension work?
AT the moment the current state pension is paid to both men and women from age 66 - but it's due to rise to 67 by 2028 and 68 by 2046.
The state pension is a recurring payment from the government most Brits start getting when they reach State Pension age.
But not everyone gets the same amount, and you are awarded depending on your National Insurance record.
For most pensioners, it forms only part of their retirement income, as they could have other pots from a workplace pension, earning and savings.
The new state pension is based on people's National Insurance records.
Workers must have 35 qualifying years of National Insurance to get the maximum amount of the new state pension.
You earn National Insurance qualifying years through work, or by getting credits, for instance when you are looking after children and claiming child benefit.
If you have gaps, you can top up your record by paying in voluntary National Insurance contributions.
To get the old, full basic state pension, you will need 30 years of contributions or credits.
You will need at least 10 years on your NI record to get any state pension.
Do you have a money problem that needs sorting? Get in touch by emailing [email protected].
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