4 taxes to watch out for regarding pensions

4 taxes to watch out for regarding pensions

This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Wealth Solutions in our Edgbaston or Warwick offices.

Looking to save tax-efficiently for retirement? Pensions are widely seen as highly effective for maximising your nest egg. However, the UK’s tax landscape is complex and subject to change, which can lead some households to make decisions which limit wealth growth potential. In this guide, our financial planners in Edgbaston and Warwick explain four important taxes to look out for when considering your retirement plan. We hope this is helpful to you. If you’d like to speak to one of our professional financial advisers then you can reach us via:

T: Edgbaston 0121 446 5815
T: Warwick 01926 888091
E: [email protected]

#1 Tax on contributions

Each tax year, a UK resident can normally contribute up to £40,000 into his/her pension; or, up to 100% of their earnings (whichever is lower). Keeping within this limit allows you to claim tax relief on your contributions – equivalent to your highest rate of income tax. Effectively, this can amount to a 20% “boost” for a Basic Rate taxpayer, or 40% for a Higher Rate taxpayer.

To avoid a tax charge, it makes sense to keep within your annual allowance. However, certain rules can extend or reduce this depending on your circumstances. This can lead to inadvertently exceeding your allowance if you are not careful. These rules include:

  • Having a high income. For every £2 of ‘adjusted income’ above £240,000, your annual allowance is reduced by £1. The most it can go down to is £4,000.
  • Using “carry forward”. You can extend your annual allowance by adding any unused annual allowance from the previous three tax years.
  • Triggering the MPAA rules. The Money Purchase Annual Allowance (MPAA) reduces your annual allowance to £4,000 when certain conditions trigger the rules.

#2 Lifetime allowance excess charge

There is a total “cap” on how much you can save into your pension(s), tax-free, called the lifetime allowance. In 2022-23, this is currently frozen at £1,073,100. Any excess taken as a lump sum is charged at 55%; anything taken as income will be taxed at 25%.

It is easier to exceed the lifetime allowance than many people realise. Those with generous workplace pension schemes are particularly at risk. Here, it can help to work with a qualified financial adviser far in advance of your retirement to help you make use of other tax-efficient vehicles in your wider strategy. This could include ISAs, Lifetime ISAs (LISAs), bonds, and investment accounts. All of these wrappers have their own advantages and limitations. The best approach will depend on your circumstances and what you want to achieve.

#3 Income tax

Since the 2015 Pension Freedoms, many people with a defined contribution pension have been able to withdraw 25% of their fund value (from the age of 55) without a tax charge, subject to the lifetime allowance. Withdrawing anything above this, however, is subject to income tax. Without careful planning, this can push some people needlessly into a higher tax bracket.

Your own pension income (e.g. from drawdown) also needs to be planned in light of your other income sources in retirement. In particular, your State Pension should start providing income once you claim it (after reaching State Pension age, which is 66 in 2022-23). Currently, the full new State Pension provides £9,627.80 per year. If this is your only income then you should not pay any income tax, since everything falls within your £12,570 Personal Allowance. However, your own pension withdrawals and/or annuity income could take you above this.

One idea for couples to mitigate income tax in retirement is to ensure that each person has a strong retirement fund of their own. This is because income tax is levied on individuals – not on households. This means that each of you gets a £12,570 yearly Personal Allowance on pension income, as well as the option of a 25% tax-free lump sum from age 55 (rising to 57 from 2028).

#4 Inheritance tax

In 2022-23, those with a defined contribution pension can pass it down to loved ones after death, tax-free, as an inheritance. This means that pensions can be a valuable tool in estate planning to mitigate IHT (inheritance tax); not just for retirement planning. For instance, you might choose to focus on using your ISA, Buy to Let income and/or savings in a regular account to fund your lifestyle earlier in retirement, since these cannot be passed down to beneficiaries IHT-free. However, certain tax rules regarding pensions can complicate your estate plan.

For instance, if you die after the age of 75, then any funds your beneficiaries withdraw from your pension will be subject to income tax. Without careful planning, this could push them into a higher tax bracket. However, if you die before age 75, your beneficiaries can withdraw pension funds as they see fit without an income tax liability. If you have a defined benefit pension when you die, then the income can typically be paid to a dependent such as a spouse, civil partner or child under age 23. However, if it is paid to another person then the income is likely to be taxed as an unauthorised payment, at 55%. Your State Pension cannot be “inherited” in the same way as a pension pot, although your surviving spouse or civil partner may be able to claim an extra payment.


We hope this content has been informative and inspired you to develop your own financial plan. Please get in touch if you’d like to discuss these matters with us via a free, no-commitment consultation with a member of our team:

T: Edgbaston 0121 446 5815
T: Warwick 01926 888091
E: [email protected]

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