Tax burden on pensioners surges: how to cut your bill

New government figures confirm just how much fiscal drag is impacting retirees’ tax bills.

In just 12 months, the number of pensioners paying income tax has shot up by more than one million, according to the latest personal income statistics from HMRC, published in May.

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In 2023-24, there were 8.16 million taxpayers over state pension age, compared to 7.14 million in the previous year.

Income tax thresholds have been frozen since 2021-22 and aren’t scheduled to thaw until April 2031.

That means as incomes rise, more retirees are starting to pay tax for the first time. But it also means that those retirees who already pay tax, are being dragged into higher-rate brackets.

Last year, research from pensions consultancy LCP, found that the number of retirees paying income tax at either the higher or additional tax rate had doubled in four years, reaching just over one million (equivalent to one in nine retirees).

This doesn’t just mean a bigger income tax bill. Even if your income only exceeds the higher-rate threshold by a marginal amount, your personal savings allowance for savings interest will drop from £1,000 to £500 and, if tax is payable, the rate you pay will rise from 20% to 40% (42% from 2027).

If you’re faced with a capital gains tax (CGT) bill when you sell investments, the rate you’ll pay will also jump from 18% to 24%, once you become a higher-rate taxpayer.

How retirees’ income is taxed

Advisers report that there is a fair bit of confusion around how retirees’ incomes are taxed.

But although you won’t have to pay any more national insurance contributions (NIC) once you reach state pension age, your income will otherwise continue to be taxed in exactly the same way.

You don’t get a different personal allowance or pay different rates of tax.

The amount of tax that you pay will be based on your total income, including the state pension, private pensions and any earnings – if you still work in some capacity. Depending on your circumstances, you may also need to factor in rental income from property and income from savings and investments that aren’t held in an individual savings account (ISA) or a pension.

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Normally, your tax will be deducted by your private pension provider when you make withdrawals and this will factor in your state pension income.

But, if your income is more complicated and from multiple sources, you may also need to complete a self-assessment tax return each year and pay any tax that’s owing direct to HMRC yourself.

How to pay less tax

Although the growing tax burden on retirees is indisputable, there are often more opportunities to manage your income tax effectively, once you’re no longer working.

That’s because – if you’re using pension drawdown, at least – you’ve got the flexibility to decide how much income to take and keep your tax bill under control. (If you have an annuity, you cannot change your income.)

Get to grips with tax thresholds

As a starting point, it’s essential you know the current tax thresholds and understand when higher rates will kick in.

How your income is taxed:

• Income up to £12,570 (the personal allowance) – 0%
• Income between £12,571 to £50,270 (basic rate) – 20%
• Income between £50,271 to £125,140 (higher rate) – 40%
• Income over £125,140 (additional rate) – 45%

(Note - different rates and boundaries apply in Scotland)

Wealthy retirees with income over £100,000 a year, should also be aware that their personal allowance will start being tapered away at this six-figure point and removed altogether once it reaches £125,140. This means that you could end up paying tax at an effective rate of 60% on income between these two points.

The number of retirees caught in this “60% tax trap” has more than doubled in the last three years, reaching 77,000 in 2024-25, according to a freedom of information request from interactive investor.

Keep a close eye on your overall income

Whatever your income, if you want to manage it tax effectively, you’ll need to keep tabs on the exact amount of money you’ve got coming in over the course of the year.

Once you know the income thresholds where your tax rate will jump up, you might find that you’re able to keep your income below the relevant thresholds.

This could be particularly helpful if, for example, you know you’ve got a more expensive year in the pipeline.

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Let’s say you’re a basic-rate taxpayer and you’re comfortably below the higher-rate tax threshold, but you know you are likely to exceed it the following year. You could withdraw the surplus income this year and set it aside until you need it to prevent you becoming a higher-rate taxpayer further down the line.

Make the most of money from tax-free sources

Keeping your income below the required thresholds can be easier said than done.

If you need to access more of your retirement savings, you may, understandably, not want to deny yourself just to keep your tax bill down.

This is where a well-funded stocks and shares ISA can be the perfect partner to your pension in retirement.

All ISA withdrawals are tax-free, meaning you can use them to top up your retirement income without increasing your tax bill.

And, if it’s not needed, it should still continue to benefit from tax-free stock market growth.

You can also take 25% of your pension tax-free.

Although lots of people like to get their hands on their tax-free lump sum as soon as they retire, there could be a logic to taking it in stages, and using it as a way to tax-effectively top up your income as your retirement progresses.

This is particularly sensible if you don’t have specific expenses you need your tax-free cash for and it just ends up sitting in a savings account (where you’ll likely pay tax on your savings interest too).

Team up with your partner

If you’re married – or have combined finances with your partner – you can also work together to reduce your collective tax bill.

By paying attention to whose pot a pension withdrawal comes from, you’ll be able to make sure you are taking advantage of both of your allowances and it could prevent one of you paying higher-rate tax unnecessarily.

Married couples and civil partners may also be able to spread their collective wealth between them to make the most of each individual’s ISA and personal savings allowances.

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Some retirees may also be able to take advantage of the marriage allowance.

For example, if one of you doesn’t pay tax and the other pays basic rate, the non-taxpayer can transfer £1,260 of their £12,570 personal allowance to the other. This can save you £252 a year and, if you discover that you’ve been eligible for a while, you could put in a claim for up to four years that you’ve missed and get up to £1,008 back from HMRC.

Plan ahead

You won’t be alone if you’re worried about the amount of tax you’re paying, or the impact it could have on your retirement income.

But you may be able to take the edge off your tax bill with a bit of forethought and planning.

By taking the time to think about how much income you’ll need – including how this might vary from one year to the next – and which pots you’ll take your money from, it’s possible to structure your income in a way that will prevent you paying unnecessary tax.

It can be complicated, especially if you have income from lots of different sources, but professional advice can help if you’re not sure where to start or you feel like you need a helping hand.