Brits eyeing retirement should brace for potential income tax implications as an anticipated hike next April could render state pensions taxable by HMRC.
The state pension is set for a boost every April, escalating by the highest of either average earnings growth, inflation, or 2.5%, courtesy of the triple lock mechanism.
Fresh figures indicating a 4.5% rise in earnings growth suggest the full state pension could swell by approximately £500, reaching £12,061 annually, alarmingly close to the personal allowance for income tax at £12,570.
The personal allowance represents the amount each UK resident can earn tax-free annually, currently set at £12,570, with a 20% tax applied thereafter. Upon retirement, all income streams, including state, private, and occupational pensions, are aggregated to determine when this threshold is surpassed.
Lily Megson, Policy Director at My Pension Expert, cautioned: “It is often overlooked that people pay income tax on their retirement income, with any money they withdraw from their pension effectively counting as an ordinary income. As people’s pensions increase in size but tax thresholds remain frozen, this will only become a more pertinent issue.”
Many individuals have had to incorporate a tax bill into their retirement planning, but new figures are placing future retirees in a “bizarre scenario of paying tax on a benefit” alone.
Becky O’Connor, Director of Public Affairs at PensionBee, told the Express: “The odd prospect now is that pensioners who only receive the full state pension might find that soon, this income alone pushes them over the allowance limit.
“This could be an unexpected and unwelcome development for millions of people on relatively modest, state-funded retirement incomes.”
The personal allowance threshold is currently frozen at £12,570 by the government and Becky expressed hope it might be lifted soon to avoid this predicament.
However, if it isn’t raised to ensure state pension remains an inherently untaxed benefit, the pension expert recommended: “It makes sense even for those with no or little income from private pensions to consider how much they might need to set aside in retirement to pay their annual tax bill, which they would pay via self-assessment tax returns.”
She also pointed out that ISAs, which are inherently tax-free savings vehicles, can be incredibly useful in this predicament. Becky continued: “Using ISAs in the years approaching retirement can be a useful way of reducing the tax owed on retirement income, alongside pensions.”
Lily highlighted the importance of consulting an independent financial advisor for those looking to optimise their tax situation with regards to retirement funds. She pointed out: “Anyone planning their retirement finances must ensure income tax contributions are factored into the equation. Naturally, the amount of tax that must be paid is dictated by a person’s retirement income, so the picture will look very different from person to person – this is why seeking independent financial advice can be so valuable, given the advisor will look at your circumstances and expected retirement income and then help you understand what tax commitments you may have in retirement.”
