Dealing with income tax
Dealing with income tax
Taxes are an accepted part of life that each of us have to come to terms with, but when it comes to retirement, many people mistakenly think that they no longer have a relationship with the exchequer. This isn't the case, though there are a number of ways you can make sure you don't pay more than you need to, managing your money effectively and prudently for the future.
Understanding income tax
Retirement income is taxed in the same way as any other person's income is, and this means that any money you receive via an annuity or withdrawal is added to any other form of income you might receive, and the combined sum is taxed.
Taking into account any allowances you might receive (married couple's allowance, for example), if your overall income during a year is less than the £11,850* personal allowance, you won't need to pay tax.
Earn over this and you'll start paying basic rate (20% on earnings between £11,851 and £46,350*), higher rate (40% on incomes between £46,351 and £150,000) or additional rate (45% on incomes over £150,000). If you're receiving too much from your pension each year, you could end up losing a huge chunk of it to the taxman, a particular issue with lump sum withdrawals.
If you're over 55 years old, you are able to withdraw some or all of your pension as a lump sum. The first 25% of this money can be withdrawn tax free, but anything above this amount is taxed as part of your income.
You have a variety of options when it comes to withdrawing lump sums, although some are better from a tax point of view than others. If your pension allows it, you could withdraw the entire amount, although you would almost certainly lose a large portion of it, given that the large sum would likely stray into the higher and additional tax bands.
You have the option of withdrawing money directly from your pension pot (i.e. money that hasn’t been used to buy an annuity or drawdown product). You can withdraw small amounts each year. 25% of each payment is tax-free with the remainder taxable.
If you decide to invest in a drawdown product, you can take the full 25% tax free cash in one go. The remainder is invested and then income can be withdrawn whenever you choose.
Manage the admin
It's very important that you keep on top of your tax affairs, as you could be hit with fines if you fail to pay the correct amount. Keep a spreadsheet of your income streams – pension payments, savings, dividends and so on – and be sure to complete a self-assessment tax form if you receive any income that isn't through work.
When deciding to make withdrawals from your pension pot, don't scrimp on the number-crunching – staying in the know will save you money make sure you're not breaking the law.
*This information is correct for the tax year 2018/19 and is for the UK - excluding Scotland.
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