Paying more tax than you need to is one of the quiet ways a retirement pot gets smaller than it should. The good news is that, with a bit of planning, there is often real scope to reduce the tax you pay, both while you are still working and once you have retired. The best way to show how is with real examples. Here are three (names changed, shared with consent) that illustrate how using pensions, ISAs and your allowances can make a genuine difference. If you would value tax advice for your own situation, these show the kind of thinking we bring.
Example 1: funding a pension while still earning
Jim came to us at 58, still working freelance and hoping to retire within a few years. He had built a reasonable pension, but also had about £25,000 sitting in cash as a rainy-day fund, earning little and, with inflation running ahead of his savings rate, effectively losing value in real terms.
Because pension contributions attract tax relief, and because how much you can pay in is linked to your earnings while you are still working, we advised Jim to move some of that idle cash into his pension while he still could. He paid in £16,000, which basic-rate tax relief topped up to £20,000 straight away, before any investment growth. Had he been a higher-rate taxpayer, he could have claimed back up to a further £4,000 through his tax return, meaning £20,000 in his pension for an effective cost of around £12,000. He kept £9,000 in cash for emergencies and brought his retirement date closer.
Example 2: using your personal allowance in retirement
Mary retired at 63 with both a pension and a good sum in cash. Her plan was to live off the cash for a couple of years to let her pension grow, sensible on the face of it, since leaving investments to compound is usually a good thing.
But it overlooked her tax position. Like most people, Mary had a personal allowance (currently £12,570) she could receive each year tax-free. In retirement with no taxable income, that allowance was going completely unused, and it cannot be carried forward: you use it in the year or lose it. Drawn later, that same money might have been taxed at basic rate. So we advised her to draw £12,570 a year from the taxable part of her pension, using up her allowance, and simply reinvest what she did not need. Same money, but structured to waste none of her tax-free band.
Example 3: using both partners’ allowances
Leigh and Rita, in their fifties, assumed they would rely mainly on Leigh’s larger pension in retirement, aiming for a joint income of around £24,000. Rita had taken career breaks to raise their children and had a much smaller pension.
We pointed out that each of them has their own personal allowance, so a couple can receive around £25,140 between them (2 x £12,570) before paying any Income Tax. By drawing on both of their pensions rather than just Leigh’s, they could take their £24,000 income entirely within their combined allowances, tax-free, and keep their 25% tax-free cash entitlements intact for later. The small surplus was reinvested. Planning as a couple, rather than defaulting to the ‘main’ pension, cut their tax bill to nothing.
The principles behind the examples
Three simple ideas run through all of these:
- Use tax relief while you can: funding a pension from earnings, especially as a higher-rate taxpayer, is one of the most powerful ways to reduce tax.
- Never waste an allowance: personal allowances (and ISA allowances) reset each year and cannot be carried forward, so drawing income to use them, even if you reinvest it, can save tax later.
- Plan as a household: using both partners’ allowances and pensions often beats relying on one person’s.
The right approach depends entirely on your circumstances, and tax rules change, so these are illustrations rather than recommendations. Verify the current allowances before acting.