The government’s latest way to take money from pensioners

It seemed like a big win for pensioners when the Chancellor, Jeremy Hunt, announced in November’s Autumn Statement that the ‘triple lock’ would stay and the state pension would go up by 8.5 per cent in April 2024. What a victory for retirees, we all thought! It will mean that pensioners will get around £11,500 a year on the full state pension. Fab!

Then the cold light of reality showed up the flaws. Putting the state pension up while keeping the income tax threshold frozen at £12,570, means that this income boost to pensioners will push tens of thousands into paying tax if they have money from sources outside of the state pension.

What is the triple lock?

Back in 2011, the then Conservative-led collation Government introduced the ‘triple-lock’ which guarantees to increase the basic state pension and single tier state pension by the highest of either average earnings, inflation (the CPI) or 2.5 per cent.

This year, the highest of those three, back in the summer, was average earnings at a shock 8.5 per cent. There was debate over whether the government would stay true to the triple lock and implement this increase to the state pension. But they did, costing the tax-payer billions. For every 1 per cent increase in the state pension, the government needs to find an extra £900m a year to pay for it.

Many pensioners rejoiced at the increase…until they started to realise the tax implications!

Kevan Ramanauckis, pensions technical specialist at Canada Life says “While an inflation proof increase of 8.5 per cent …is welcome, we need to remember someone in receipt of a full state pension will now be just £1,000 away from paying income tax, even if they have no other source of income. Pensioners in the old state pension scheme and even some in the new system may find themselves being drawn into the income tax net for the first time.”

Currently 12.6m people claim a state pension, of which 653,444 are aged over 90. The average weekly state pension is £166.13 (women £156.35 vs £177.65 for men). The new state pension average will be £173.51 (women £170.61 vs £175.54 for men)

What can you do can do to cut tax for yourself?

Dean Butler, Managing Director for Retail at the pensions company Standard Life says “one of the most common challenges we see is that people want to withdraw their pension in one go. However, only 25% of a pension can be accessed tax free and if you withdraw it all in one go, there’s a chance you could end up paying the higher or even additional rate of tax on a portion of your savings which will leave you with less to live on in the long-run.

“The good news is that the tax free element of your pension can be taken at different times with most pensions, allowing people to spread the benefit over many years. By keeping the majority of your pension invested, it also provides the possibility of further tax free investment growth. Once the tax free element has gone, people have the option to take sums that will keep them below certain income tax thresholds.”

Mind you, don’t scrimp and save just to save on tax. It’s worth remembering that that minimum income most people need for a basic retirement has been estimated at £12,800 for a single person.

Even if you take more income each year, and paying tax on it, it’s likely to be worth it to give you a more comfortable retirement. The biggest challenge with taking income from a pension is that none of us really knows how long it may need to last and it’s a judgement call about how much to take when. My feeling is always that it’s best to assume that you’re going to last a good long time. If you do that then you will save money for yourself and, if not, you will at least have money to hand to the next generation!

Use your ISA

Dean Butler adds “for people with other forms of savings it can make sense to access them before touching pensions. Money withdrawn from an ISA for example is not taxable so people are able to top up their state pension income that way. This has an added benefit in that pensions don’t form part of people’s estates so they can be passed on tax free or at the recipient’s marginal rate of tax. However, for those with modest pots, it’s unlikely to make sense to deprive yourself of income just to leave an inheritance.”

Get advice

What to do with your pension pot and other investments in retirement is a really big issue and it’s one where it’s worth paying money for good advice.

First of all, get guidance from a service like Pension Wise and then, if you’re still wondering what is best to do, pay for advice from an independent financial advisor. The first meeting is usually free so you should be able to get quite a bit from that, but for proper ongoing advice, get someone who will take an holistic view of your financial situation and help you work out what is the best way to maximise your investments and pay the least tax! Try Vouchedfor.com for financial advisors who are rated by their other clients.