There’s a lot to consider if you’re coming out of retirement. While you may be going back to work for personal as well as financial reasons, the money side of things can be complicated, with pension income treated differently to employment income.

To help you navigate the rules, we’ve put together our top four financial considerations which should help you make the most out of any return to work.

Alternatively, you may be interested in our article looking at what to do if you’re going back to work after taking a career break or looking after children.

1. Not all income is equal…

Perhaps the first thing to think about when considering a return to work is how you’ll be taxed. Returning to the labour market could leave you with as many as four separate income streams, all of which are taxed slightly differently:

• Earnings from going back to work – you may pay income tax and national insurance, as well as automatically contribute to a pension through auto-enrolment.
• Any income you start or continue to draw from your personal pension – you may pay income tax (unless you take it as tax-free cash¹), but you won’t pay national insurance.
• State pension – again, you may pay income tax, but you won’t pay national insurance.
• Investment and savings income – unless your holdings are in tax-efficient vehicles like ISAs you may pay income, capital gains or dividend taxes. Investment and savings income does not attract national insurance.

After you’ve considered the tax implications from returning to work, you may decide to stop taking income from your pension or other investments to reduce your tax bill. But you may also want to take specialist advice at this point, as this can be a complicated area of financial planning.

2. Earning more may also affect how your income is treated

As well as taxes, you need to think about what you’re allowed to earn without paying tax. These are generally referred to as ‘allowances.’ The best known is the personal allowance, which allows you to earn £12,570 in 2023/24 without paying income tax.

The one to watch, however, is your starting rate for savings, which allows you to not pay income tax on up to £5,000 of interest income if you earn below £17,570. The starting rate for savings is gradually reduced as you earn more than £12,570 a year².

If you do want to go back to work but limit your earnings, you can also defer the state pension in return for a higher amount when you do decide to take it. But it can take many years for the higher state pension to make up for the missed payments.

3. The money purchase annual allowance (MPAA)

The money purchase annual allowance is one area where the government has decided to be more generous. The MPAA limits the amount you can put back into your pension once you have already accessed it.

The MPAA was previously set at £4,000 but now stands at £10,000 for the 2023/24 tax year.

If you have already accessed your pension, this simply means that you can return to work and top your pension back up more easily.

This makes it more likely that you will be able to benefit from a new employer’s pension contributions. Under auto-enrolment rules, employees automatically contribute to a pension scheme on their earnings over £10,000. The employer contributes 4% of salary, the employee 3%, and the government 1% in the form of basic rate income tax relief.

Under the £4,000 MPAA for 2022/23, the maximum salary you could have earnt before having to give up employer contributions would have been £50,000, assuming an 8% contribution. With the £10,000 limit, you can have an income of up to £125,000 before having to opt out of contributions.

Under new pension rules, you can earn much more while still benefiting from employer contributions

Source: Vanguard calculations, gov.uk 

4. What if you end up with more income than you need?

If you do go back to work, you may of course end up with a surplus, with more money coming in than you need. You can always reduce the amount you take from your pension, allowing you to potentially build the pot back up as the investments grow and continue to benefit from a pension’s tax advantages.

A money-purchase pension like the Vanguard Personal Pension also allows you to pass on the assets to the next generation without attracting inheritance tax.

If you still have a surplus, then you can check whether you can invest more back into your pension, though you should check the rules around pension recycling. Another option is to invest in an individual savings account (ISA). You can invest up to £20,000 in an ISA for the 2023/24 year, with your investments growing free of capital gains, income and dividend taxes.

Alternatively, you may want to contribute to a Junior ISA for a young family member. Bear in mind that while anyone can contribute to a Junior ISA, only parents or parental guardians can open one.

Not just a financial consideration…

Your decision to go back to work may not be a financial one. It is important nonetheless to consider how your finances will be affected. For more information on pension allowances and other issues, visit our ‘latest thoughts’ page, where you can find helpful articles such as SIPP allowances and pension tax relief explained.

¹ You are allowed to take up to 25% of your pension as tax-free cash, subject to a limit of £268,275 unless you have fixed protection. For more information, visit the UK government website on pensions and tax-free cash. 

² For more information, visit the HMRC website.