Article
Tax traps facing those approaching retirement
5 min read 5 Nov 25
As you approach retirement, it's essential to be aware of how tax could impact your hard-earned savings. Navigating the complexities of the tax system can be challenging, but understanding these pitfalls can help you make informed decisions and protect your retirement income.
Please remember that tax rules can change and the impact of taxation and any tax relief depends on your circumstances, including where you live. This article will highlight some of the current tax traps where people can get caught out.
Tax on pension withdrawals
When you start withdrawing from your pension, it's essential to understand the tax implications. While the first 25% of your pension pot can usually be taken as a tax-free lump sum (up to a limit of £268,275), the remaining 75% is subject to income tax. Depending on the size of your withdrawals, you could move into a higher tax bracket, resulting in a larger tax bill. One way you could potentially reduce your income tax is by spreading your withdrawals over several tax years to stay within lower tax bands. However, whether this is the right thing to do or not will depend on your own circumstances and we'd recommend speaking with a financial adviser to help with tax planning.
Inheritance tax
Inheritance tax (IHT) is another potential tax liability for retirees. IHT is charged at 40% on estates above the nil-rate band, which is currently £325,000. Pensions are currently exempt from IHT, however from 6 April 2027 any money and death benefits left in your pension after you die will be included in your estate for IHT purposes. Although this rule will apply to most pensions, there may be some that are exempt.
This means more people are potentially likely to face an increased IHT liability. It’s therefore important to be aware of the different allowances to help reduce any IHT liability. This includes the nil-rate band, the residence nil-rate band and various gifting allowances. However, some of the strategies to reduce IHT can take years to become fully effective, so the sooner you can start planning the better.
The Annual Allowance
The Annual Allowance is another important consideration. This is the maximum amount you can contribute to your pension each year without facing tax charges. For the 2025/26 tax year, the standard Annual Allowance is £60,000. To avoid any tax charges keep track of your contributions. You may also be able to carry forward any unused allowance from the previous three tax years if you’re planning on going over the Annual Allowance.
The Money Purchase Annual Allowance
If you have already started receiving money from a pension you will be subject to the Money Purchase Annual Allowance (MPAA). The MPAA is like the Annual Allowance but it limits the amount you can contribute to your pension to £10,000 each year without facing tax charges. This is significantly lower than the standard Annual Allowance and can catch some retirees off guard. Be mindful of the MPAA if you plan to continue contributing to your pension after accessing it.
The Individual Lump Sum and Death Benefit Allowance
You or your beneficiaries may be able to take a tax-free lump sum of up to £1,073,100 in certain circumstances. For example, if you take a lump sum due to serious illness or your beneficiaries are paid certain lump sum death benefits. This is known as the lump sum and death benefit allowance.
If you withdraw more than this, you could face a significant tax charge on the excess amount. It's crucial to monitor your pension pot's value and consider strategies to mitigate this risk.
Conclusion
As you approach retirement, being aware of the different taxes can help you protect your savings and ensure a more comfortable and secure retirement.
Trying to navigating these tax areas can be complex and costly. This is where professional financial advice can make a significant difference. Our financial advisers can help you understand your tax liabilities, create a tailored retirement plan and ensure you're making the most of your pension.
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