Live the high life! Plan ahead to cut your tax bill in retirement

SAVING money to ensure a comfortable retirement is tricky enough, without handing free gifts to the taxman

cut tax bill in retirement, planning figures, enjoy high life, pension potGETTY

With planning the figures can really add up

Too many people pay far more tax than they need to in retirement by failing to make use of their various tax allowances.

With careful planning, many more pensioners could slash their annual tax bill, even to zero. It is possible to generate pension income of £15,000 or £20,000 a year, and possibly even more, without paying a penny to HM Revenue & Customs (HMRC).

This may come as a surprise to those on lower pension incomes who still pay thousands in tax each year. It is all perfectly legal using legitimate financial planning methods. You do not have to exploit dodgy tax loopholes or sign up to risky avoidance schemes to escape the taxman.

David Smith, financial planning director at IFAs Tilney Bestinvest, says new pension rules coming into force from April 6 will help the over-55s keep more of their pension income from the taxman. "This legislation, coupled with existing tax laws and allowances, will enable many retired people to reduce or even completely extinguish their exposure to income tax."

From April 6, everybody's personal allowance, the amount you can earn each year before paying income tax, rises to £10,600. So if you earn state pension income of, say, £7,000 a year, you will not pay a penny of tax on that.

You can then withdraw £3,600 from any company or personal pension pot, as a lump sum or over the year, and that would also be free of tax. Since 25 per cent of any pension withdrawals are free of tax, you can take another £1,200 from your pension without paying the taxman.

'They out £ That lifts your total tax-free income to £11,800 a year. Any money you take from your pension after that will be subject to income tax at your personal rate, say, 20 or 40 per cent.

from pension totally income However, people who take early retirement before their state pension kicks in may be able to take more free of tax, Smith says. "Assuming they have no other taxable income, they can take out £14,133 from their pension pot tax free, made up of £10,600 (their personal allowance), plus 25 per cent of the lump sum, which equals £3,533."

He says many married couples do this when for instance the husband retires at 65 and his younger wife decides to stop working as well, even though she is not yet eligible for her state pension. "This allows her to take a larger lump sum out of her pension without having to pay income tax on it," he says.

Andrew Tully, pensions technical director at retirement specialists MGM Advantage, says new rules from April will help some retired couples save more tax: "The Government is introducing a transferable personal allowance, which lets married couples or civil partners transfer £1,050 of their allowance to their partner."

If one partner earns most of the income, this could help reduce the couple's combined tax bill by up to £210. "The only proviso is that neither partner must pay more than basic rate income tax," Tully says.

Your tax-free Isa allowance gives you a great opportunity to generate tax-free income in retirement, because any money you withdraw is free of both income tax and capital gains tax. Yet every year Britons pay £1.1 billion worth of tax unnecessarily, because they fail to make full use of their allowance, according to figures from find-an-adviser service Unbiased.co.uk. You can save up to £15,000 in cash or stocks and shares via an Isa this year, a figure that rises to £15,240 from April.

They can take out £14,133 from their pension pot totally free of income tax

Karen Barrett, from Unbiased.co.uk, says: "If you make a lifelong habit of saving for the future, the sums can really build up. Everybody should grab their Isa allowance with both hands."

If you managed to build up £100,000 worth of Isas by the time you retire, you could take, say, 5 per cent of that each year, and leave the rest to grow.

This would add £5,000 to your annual income, free of tax. If your partner has Isa savings, you could draw an even higher tax-free income.

A little-known tax allowance aimed at savers on modest incomes will beefed up from April.

take 14,133 their Currently, savers on lower incomes pay a reduced tax rate of 10 per cent on any interest they withdraw. That will now be cut to zero. This allows savers to earn up to £10,600 a year free of tax through their personal allowance, pot free of tax' and take £5,000 worth of savings interest on top of that, lifting their total tax-free income to £15,600.

However, the tax-free band will be steadily cut, if your earnings from other sources top £10,600. Every pound you earn would shrink the tax band by the same amount, so if you earn £15,600, it disappears altogether.

Patrick Connolly, certified financial planner at Chase de Vere, says: "This will help some savers, although it makes more sense to use your cash Isa allowance instead."

To benefit, you need to register as a non-taxpayer with your bank, using HMRC form R85, or reclaim tax deducted using form R40.

Taxpayers are expected to squander £158 million this year by failing to make use of their capital gains tax (CGT) allowance. This lets you take capital gains from stocks and shares, investment funds such as unit trusts, and property. The allowance is worth up to £11,100 a year from April.

If you fancy a flutter, you have another option, says Patrick Connolly. "All your winnings on Premium Bonds, from National Savings & Investments, are paid free of tax."

You can invest from £100, and the more bonds you buy, the greater your chance of winning. The current prize rate on premium bonds is a modest 1.35 per cent, Connolly adds.

"You might win £1 million in its monthly jackpot, but alternatively, you might win nothing at all."

Would you like to receive news notifications from Daily Express?