An increase in the state pension combined with frozen income tax thresholds mean there’s never been a more important time to ensure your retirement is as tax efficient as it can be.

On 6 April, the state pension rose to £221.20 per week, which works out at just over £11,500 a year. That’s an increase of 23% since April 2021.

While the increase is welcome, it could mean retirees face a bigger income tax bill this year than they did previously. This is because the personal allowance (the amount of income you can earn each year before being taxed) has stayed frozen at £12,570 over the last three years and the higher-rate tax threshold has stayed frozen at £50,270.

Fortunately, there are ways to potentially reduce the amount of tax you pay in retirement. The tips below won’t be suitable for everyone – we recommend speaking to a financial adviser if you’re unsure – but they’re useful pointers to consider.

1. Don’t draw more income than you need

With the state pension now using up an even larger share of the personal allowance, the amount of tax-free income you can expect to draw from private pensions has reduced further. As a reminder, you can typically draw up to 25% of your pension as tax-free cash (capped at £268,275) and the rest is taxed at your normal rate of income tax.

Tax isn’t a reason to make drastic changes to your living standards, but it may be wise to check you’re only drawing the income you need. Taking too much income not only increases the risk of you depleting your pension pot too quickly but could also land you with an unnecessary tax bill.

What’s more, if you end up putting excess income in a cash savings account, any returns that exceed your personal savings allowance and/or starting rate for savings (see section 3 below) may be subject to tax. By leaving the money in your pension, there’s the opportunity for further tax-free growth.

2. Continue sheltering your investments in an ISA

You might not be able to afford to add new money to an individual savings account (ISA) now that you’re retired, but ISAs are still a useful way of sheltering existing investments from tax.

In an ISA, your investments can grow free from the income tax you might pay on the dividends1 or interest you receive, as well as the capital gains tax (CGT) that could be applied on any profits (‘gains’) you make when selling assets. If you invest outside an ISA, you could end up paying tax on dividends, interest and profits.

So, if you have investments in a general account, you might want to think about moving these into an ISA to reduce or even eliminate these potential tax liabilities. The process for doing this is called ‘bed and ISA’, which you can read more about in this earlier article. Bear in mind that bed and ISA transactions will count towards your ISA allowance, which is currently £20,000 a year.

3. Consider other sources of retirement income

Income in retirement doesn’t have to come from pensions alone. In fact, using other savings and investments to supplement your pension income could prove tax efficient. Other sources of retirement income to consider include:

  • ISAs: you can withdraw as much money as you like from ISAs without paying any tax.

  • Savings accounts: basic-rate taxpayers can earn up to £1,000 of tax-free interest on savings each year. This is called the ‘personal savings allowance’. It reduces to £500 for higher-rate taxpayers and is £0 for additional-rate taxpayers. You may also earn up to £5,000 of tax-free interest (the ‘starting rate for savings’) if your other income is less than £17,5702.

  • General account: if you have investments in a general account, you can earn tax-free capital gains of up to £3,000 and tax-free dividends of up to £500 in the 2024-25 tax year.

The way in which you draw income from your various investment and savings pots each year could make a big difference to your overall tax bill in retirement. It’s usually wise to take income and capital from general accounts before ISAs and pensions, so that you preserve the tax wrapper benefits for as long as possible. However, what’s right for you will depend on your individual circumstances, so we’d suggest speaking to a financial adviser first.

4. Plan your finances as a couple

If you have a partner, it usually makes sense to plan your finances together. As a couple, you can effectively double up your allowances – so that’s two personal allowances, two ISA allowances, two CGT allowances, and so on. Maximising both partners’ allowances is a relatively simple way of lowering your overall tax bill.

If you’re married or in a civil partnership, you might benefit from the marriage allowance. This lets you transfer up to £1,260 of your personal allowance to your spouse or civil partner. To qualify, one of you must have earnings below £12,570 and the other must be paying basic-rate income tax.

Spouses and civil partners can also transfer savings and investments from one partner to the other without paying tax. This might come in handy if one partner is a higher-rate taxpayer and the other is a basic-rate taxpayer. By transferring certain assets into the basic-rate taxpayer’s name, you could benefit from a lower rate of tax on income and capital gains. However, this will depend on your tax position and the mix of savings and investments you each own. If you’re at all unsure, speak to a financial adviser.

Dividends are the payments some companies make to their shareholders out of their profits. – Tax on savings interest

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Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

The eligibility to invest in either ISA or Junior ISA depends on individual circumstances and all tax rules may change in future.

Any tax reliefs referred to are those available under current legislation, which may change, and their availability and value will depend on your individual circumstances. If you have questions relating to your specific tax situation, please contact your tax adviser.

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