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Navigating retirement taxes: a beginner's guide

We take a look at retirement taxes in the UK, including what they are and what you can do to ease your tax burden.

Retirement taxes Retirement planning Tax planning

Date published: 31 March 2023

This article is not advice. If you would like to receive advice on your savings and investments, consider speaking to a Financial Adviser.

Navigating retirement taxes: a beginner's guide

Last updated: Tuesday, 6 August 2024

Taxes can eat into your hard-earned retirement savings and affect your financial flexibility. So, whether you’re approaching retirement or already enjoying it, it’s good to be aware of the tax implications of your income.

In this article, we take a look at retirement taxes in the UK, including what they are, and what you can do to ease your tax burden. So you can take home more, worry less, and enjoy life.

Types of retirement taxes in the UK

In retirement, you may be subject to several types of taxes, including:

Income Tax

You’ll need to pay Income Tax on any income you enjoy in retirement over your Personal Allowance – whether that’s from a State Pension, private pension, property, or other investments.

How Income Tax works

The amount of Income Tax you pay in retirement will depend on how much you receive. In general, the more you earn, the higher your tax rate will be.

What is a Personal Allowance?

A Personal Allowance is the amount of annual income you can earn before you start paying tax. For the current tax year , the Personal Allowance is £12,570. For everything over this amount, you’ll pay Income Tax at the following rates:

Basic rate: 20% on income between £12,571 to £50,270
Higher rate: 40% on income between £50,271 to £125,140
Additional rate: 45% on income above £125,140

National Insurance Contributions

UK workers and employers make National Insurance Contributions (NICs) to fund the State Pension and other social security benefits. When you reach State Pension age (currently 66), you may be entitled to receive the UK State Pension based on the amount of NICs you’ve paid throughout your working life.

How National Insurance Tax works

You pay National Insurance when you’re employed or self-employed, depending on how much you earn. But when you reach the State Pension age, you don’t have to pay NICs – unless you’re self-employed and pay Class 4 contributions (more on those in a second). Once you reach this age, you stop paying Class 4 contributions at the end of the tax year.

What are Class 4 contributions?

Class 4 contributions help fund the UK's State Pension and various other benefits. If you’re self-employed, you usually pay Class 4 National Insurance rates.

You’ll pay 6% on profits between £12,570 and £50,270. And 2% on profits over £50,270.

Class 4 contributions are usually calculated and paid through the annual Self Assessment tax return process, where you declare your income, and calculate your tax and National Insurance contributions.

Inheritance Tax

Inheritance Tax is a tax on the value of your estate when you die. If the value of your estate – including any property, assets, and money you own – exceeds a certain threshold, your beneficiaries will be subject to a hefty Inheritance Tax.

How Inheritance Tax works

The standard Inheritance Tax threshold (also known as the nil rate band) is set at £325,000. Estates valued up to this amount are not subject to Inheritance Tax. But any value exceeding this threshold is taxed at 40%. The tax must be paid within six months of the wealth transfer.

An additional residence nil rate band, fixed at £175,000 until 5 April 2026, can be applied if the deceased's estate includes residential property, which passes to direct descendants. This can significantly reduce the taxable portion of an estate.

Several exemptions can further alleviate the tax burden. For instance, transfers to a spouse or civil partner are exempt from Inheritance Tax. Charitable donations made from the estate are also exempt.

Capital Gains Tax

If you sell any assets, such as property, a business, or investments during retirement, you’ll most likely be subject to Capital Gains Tax. This tax is calculated based on the profit or ‘gains’ you make from the sale of the asset, but you only pay on profits above the annual tax-free allowance. The current tax-free allowance (called the Annual Exempt Amount) is £3,000.

How Capital Gains Tax works

For the current tax year, if you’re a higher or additional rate taxpayer you’ll pay:

24% on gains from residential property
28% on gains from ‘carried interest’ if you manage an investment fund
20% on gains from other chargeable assets (e.g. stocks, bonds, commercial property)

However, if you’re a basic rate taxpayer you may pay more depending on the size of your profit when added to your taxable income. If the amount comes to more than the basic Income Tax band (see in ‘Income Tax’ above), you’ll pay 20%.

Reducing your tax bill during retirement

There are several ways to minimise your tax liability during retirement:

Draw 25% of your private pension as a tax-free lump sum.
Take an annual pension income up to the tax-free allowance limit of £12,570.
Make larger contributions to your pension pot to receive tax relief from the government.
Withdraw from tax-efficient Individual Savings Accounts (also called ISAs) before tapping into other accounts.
Defer your State Pension to gain a 1% government boost to your pension every nine weeks.
Make full use of your Capital Gains Tax allowances to minimise the tax you pay when selling assets.
Transfer your assets tax-free to a spouse or civil partner to benefit from their lower tax rate.
Gift money or assets to your family members each year to reduce the value of your estate and the impact of Inheritance Tax.

Taxes are complex, so to ensure you aren’t caught out by the tax man, it’s a good idea to establish a plan. Consider working with a Financial Adviser or tax expert to make sure you understand all your options, and take full advantage of the schemes and allowances on offer.