Retirement can mean quite a few changes in your everyday life. It’s also a big shakeup to your income, and knowing how to plan for paying income tax in retirement is essential. Knowing what income is taxable can guarantee you keep your finances in order.
What is taxable income?
There are many ways you might receive income even after you stop working full-time. However, not all income is subject to tax. You generally have to pay income tax when you receive:
- Money as earned income through wages, pension payments, and profits from self-employment
- Certain state benefits such as Jobseeker’s Allowance
- Income from your savings and investments in the form of dividends or interest
What might this look like in terms of retirement income?
Income from pensions
You are likely to receive income from two different pensions: the state pension and workplace or personal pensions. The income you receive from these pensions is subject to tax.
We’ve previously written a guide on the state pension and taxation that you can check out here.
Your other pension income is also taxed. With workplace and private pensions, you will receive 25% of your pension pot tax-free. For the remaining 75%, you’ll pay tax.
Income from state benefits
You might also receive certain state benefits, and some of them are taxable income. Here’s a list of all taxable state benefits and links to finding out more about them:
- Bereavement Allowance
- Carer’s Allowance and Carer’s Allowance Supplement (Scotland only)
- Employment and Support Allowance
- Jobseeker’s Allowance
- Statutory Sick Pay (SSP)
On the other hand, you do not have to pay tax on Pension Credit or Disability Living Allowance (DLA).
Income from other sources
You might continue working part-time or do the occasional job even after you retire. Any compensation you get for the work you do is subject to tax.
If you have a property you rent out, you must pay income tax on any rental income you receive.
You should also know that income from your investments and savings is taxable income. For instance, you might receive dividends from a stock fund, or your bank might pay interest on your savings.
When is income tax paid?
Now that you know what income is taxable, it’s crucial to understand when the tax is paid. For most retirement income, your income is not taxed at source. This means you receive it gross. For example, the state pension is paid gross. The tax you owe is not automatically taken out of the money you receive. Instead, you must work out how much tax you need to pay.
The common income you receive gross includes:
- State pension
- State benefits
- Investment and savings income
- Self-employed income
There are certain types of income that are taxed net, meaning tax is taken out before you receive the income. If you are working for someone else, your employer takes out tax from your wages in most instances. Your pension payments from the workplace and private pensions are typically paid with tax already taken out.
Do you have to file a tax return?
What does this mean in terms of completing a tax return and paying your taxes? While your state pension is typically paid gross, you don’t have to file a tax return if you receive any other pension. Your pension provider will take off the tax you owe before paying you, including tax you might owe on your state pension. Even if you have multiple pension providers, HMRC will ask one of them to take off the tax. You’ll then receive a P60 at the end of the tax year to show how much tax you’ve paid.
For most people, if your only retirement income is your pension, you do not have to worry about self-assessment.
However, there are certain instances where you might have to file your taxes. If you’re only receiving State Pension, then you will need to file a Self-Assessment tax return. You also need to file it if you have other income sources, such as rental property or investment dividends.
Working out how much tax you must pay
There is another piece in the puzzle when it comes to taxable income. While the above is a list of all income that’s subject to tax, whether you have to pay tax and how much you pay depends on your overall income. Tax allowances can reduce the amount of tax you have to pay.
For most of your income, the Personal Allowance is the most crucial tax allowance to keep in mind. It’s an annual amount you can earn without having to pay taxes. For 2020/21, you can earn £12,500 before paying tax. If you are also claiming Marriage Allowance or Blind Person’s Allowance, the amount might be higher.
What does this mean in action? If your total income falls below £12,500 in a tax year, you do not have to pay any tax. If your income is above the threshold, you need to pay tax on the amount above the threshold. For instance, if your total income is £40,000, your taxable income would be £40,000-£12,500=£27,500. As mentioned, this might be further reduced by different tax allowances.
Useful tax calculation spreadsheet
For most retirement income, you can use the following spreadsheet to calculate taxes:
| Total taxable income | £22,950 | Private pension = £9,150 State pension = £9,600 Building society interest = £200 National Savings Income Bonds = £2,000 Annuity = £2,000 |
| Deduct certain tax allowances (Personal Allowance) | -£12,500 | |
| Deduct Blind Person’s Allowance if applicable | If registered blind, the deduction would be £2,500 | |
| The amount of taxable income you have to pay tax on | £10,450 | |
| Calculate tax liability using the tax rate | £18,650-£12,500=£6,250 Tax on £6,250 is paid at 20% rate £1,250 | Total pension income attracts the highest rate of tax, so calculate tax liability by using those: £9,150+£9,600=£18,750 |
| Deduct any special allowances, such as Married Couple’s Allowance or Marriage Allowance | -£1,000 | Total savings in the example are £2,000, which attracts the Personal Savings Allowance deduction |
| Take off any tax deducted from the income before you received it | -£1,250 -£400 | Tax on pension income would have been taken off by the pension provider. Tax on a purchased annuity is also generally taken off before payment. In the example, it would have been: Tax on purchased annuity: £2,000 at 20% |
| The amount of tax due | £240 | Tax paid: Tax on savings income £1,000 taxed at 20% rate Tax on building society interest: £200 at 20% |
You can find a tax estimate calculator online to use as well.
Plan for your income taxes
Retirement can change your financial situation. Your income sources change, and you often have to start paying more attention to how to plan your taxes. Knowing the type of income that’s taxable is an essential start for planning your taxes and better prepares you for the amount of tax you have to pay. With proper planning, you ensure you don’t end up hurting yourself financially by withdrawing too much of your private pension at once, for example.
Remember that help is available if you find planning for your taxes difficult. You can talk to a financial advisor for tips on how to plan your taxes. Those with low income can also check with Tax Help for Older People. The charity can provide assistance and information to help you plan your income taxes.
The important thing is to ensure you know your total income and what is subject to tax. You can then make the most of tax allowances and ensure you budget appropriately for your taxes.
