Record numbers of us are working after retirement age, but what are the rules? How does it affect our pensions and how much tax we pay? With prudent planning, it could be less than you think.
The meaning of the word retirement has changed beyond recognition and no longer describe what life looks like today for those of us who are over 60. Many of us now want an extended or phased transition from the 9 to 5 and fear missing out on the mental stimulation and social engagement work offers.
Since the default retirement age of 65 was ended in 2011, ‘cliff edge’ retirement has all but vanished. According to new projections from Rest Less 1, those of us aged 65-plus are likely to be responsible for at least 50% of UK employment growth in the next 10 years.
Working after 70
Whether you embrace your late 60s and 70s in full or part-time work, or you become self-employed, you’ll have tax and pension decisions to make. If in doubt, you could take advantage of our free online guidance – you don’t even need to have a pension with us. Or you could make an appointment with one of our qualified financial advisers.
Alistair McQueen, Head of Savings & Retirement at Aviva, says almost 1.4 million people are working beyond the traditional retirement age of 65 – an all-time high and nearly triple the number in 2000. It’s a trend he expects to continue.
“There are two levers most of us can pull to fund our later life: we can save more or we can work longer. Many will pull both,” he adds. “When preparing for retirement, or in retirement, remember that it's not all just about saving. Working is also one of the most powerful actions we can take. More and more people, and employers, are rising to this opportunity.”
How to keep your tax bill down
Let’s look at the practical steps you can follow to keep your tax bill to a minimum when drawing a pension while working.
The simplest way is to take only the amount you need in each tax year from your pension as the lower this is, the less tax you pay.
Of course, you need enough to live comfortably but as Unbiased.co.uk 2, the independent financial advice platform, points out: “Unlike when taking a salary, there’s less advantage to having more income than you need and putting it into savings. In most cases, it’s best to leave money inside your pension until you are sure you are going to spend it.”
While you can take all your pension pot as a lump sum from the age of 55 (rising to 57 in 2028), this could leave you with a large tax bill. If you carry on working, it makes sense to keep your money, especially the 25% tax-free element, in your pension. If you have a defined contribution scheme, this is where it can be an advantage to use flexible drawdown, which lets you vary your income from year-to-year in a tax-efficient way.
Tax benefits are subject to change and individual circumstances.
Ease into semi-retirement with phased drawdowns
If you’re planning to semi-retire or opting for a part-time job, you could use the 25% of your tax-free pension in phased drawdowns to cover the drop in your earned income. This will allow you to minimise your tax bill during these years and make the most of your tax-free allowances as you relax into retirement.
Whether your pension is a defined contribution or a defined benefit scheme, the unavoidable reality is that income from it (apart from the 25% tax-free element) is taxed like all other earnings.
For this reason, your tax-free Personal Allowance of £12,500 for tax year 2020/21 is important. Once you earn between £12,501 and £50,000, you pay the basic 20% tax rate. The 40% bracket covers £50,001 to £150,000 and for income above £150,000, you pay 45%.
Plan what you need to spend
Dr Marian Hartigan is a retired senior teacher and educational consultant based in Lincolnshire. Still working after the age of 70, she urges people to plan the income they need carefully.
“While I’m fortunate to have a Teachers’ Pension, State Pension, global investment portfolio and income from examination fees, I do reluctantly pay a 40% tax rate. I was prepared for this but would advise anyone approaching retirement who wants to continue working to calculate what their total income might be and take advice.”
With his State Pension age approaching, Stephen McCreery is another firm believer in prudent planning. He combines a holiday let business in Ceredigion with paid part-time research.
Stephen says: “As I manage my own accounts, I’ve been careful to keep within the 20% tax bracket. To do this, I’ve sold part of a property portfolio to help fund the future and intend to combine this with my State Pension and an RAF pension I already draw upon. While you can’t control the incoming costs in retirement, you can certainly control your outgoings.”
Avoid unnecessary withdrawals
To be tax savvy with a defined contribution scheme, you need to be strategic about your withdrawals from the taxable 75% portion of your pension pot. If you can, spread them throughout the year, and over a number of tax years, so you can benefit from your tax-free allowances. Avoid unnecessary or large one-off withdrawals that could tip you into a higher tax bracket.
Bear in mind, if you’re still working, your salary plus pension withdrawal may push you into a higher tax band than if you just took the tax-free amount on its own.
Remember that your income stops when the money in your pension runs out and the more money you take, the more likely it is that your pension will run out faster.
Money you get from your pension is looked at when working out your entitlement to any state benefits. Taking any withdrawals may affect the benefits you can receive.
Benefit from tax-free boosters
Cash or Stocks and Shares ISAs (Individual Savings Accounts) offer another popular way to cut down on taxable pension withdrawals. With an ISA, you never pay tax on the interest and can make tax-free withdrawals whenever you need. However, with a Stocks and Shares ISA, investments can fall as well as rise in value so you could get back less than you invest.
Belfast-based freelance journalist Ann Brady explains why she opted for an ISA. “Now I’m in my mid-60s, I have gradually shifted from full-time to consultancy work for an international organisation in Geneva. I’m therefore relying on ongoing consultancy fees, drawing my State Pension and flexible drawdown from a private pension with advice. As I’m in the 40% tax band, I’ve deliberately invested in a tax-free ISA and Premium Bonds to help offset this.”
Collecting your State Pension
With personal pensions you can access your money once you turn 55. The State Pension age is currently 65 for men and women, rising to 66 by October 2020, and 67 between 2026 and 2028.
Currently worth £8,767.20 a year, your State Pension can be an important addition to retirement income (providing you’ve paid 35 years’ worth of National Insurance). You should therefore check when you can claim.
If you’re working after your pension age, another useful way to limit unnecessary tax, and boost your income down the road, is to delay taking your State Pension. For each year you defer, you’ll get an increase of around 5.8%.
Just be aware that deferring only really pays off around nine or 10 years after you decide to take it. If that’s not a problem, then consider it a really good savings account.