Pensioners can “sidestep” an income “tax trap” by utilising their tax-free pension allowance more strategically, experts have said.
An analysis by the OBR shows that an estimated 34.6 million people now pay income tax, an increase of around 500,000 people as a direct result of tax threshold freezes.
By 2027 to 2028, this number is estimated to increase to 38.2 million, meaning that a further 3.2 million people will be brought into income tax compared to what this total would have sat at with indexation and no tax threshold freezes.
Those of working age are set to be hit hardest, but the freeze to tax thresholds also has implications for those trying to get by on their pension.
Bradley Post, MD of RIFT, a tax and accounting specialist, commented: “Tax threshold freezes are set to impact us all and while pensioners will be less affected, it certainly pays to know where you stand with the tax man and what you might owe if you creep above the income tax threshold.”
Currently, the full state pension sits at £10,600 per year, just £1,970 off of the income tax threshold of £12,570.
According to PensionBee, the average private pension pot across the UK is worth around £17,379. However, what many pensioners may not realise is that while they can take 25 percent of their pension pot free of tax, according to Mr Post, they don’t have to take this all in one go.
Mr Post said: “The good news is that there are ways that you can sidestep the income tax trap and the best way to start is by utilising your 25 percent tax-free pension pot allowance over a longer period of time.
“This will allow you to benefit from your hard-earned private pension for many years without paying a penny to the taxman.”
According to Mr Post, if someone were to set their gross annual private pension withdrawal at £2,627, only £1,970 would contribute to their personal allowance, allowing them to stay within the £12,570 income tax threshold and avoid paying tax on their hard-earned pension.
Based on the average UK private pension pot of £17,379, and at current allowances, this would see their private pension stretch over a total of seven years without paying a “single penny” in tax.
There are additional ways people can make their pension work harder and more tax-efficiently.
According to Mr Post, lower-earning pensioners taking a pension of less than the £12,570 income tax threshold each year are also eligible to take as much as £5,000 in savings interest completely tax-free.
He said: “While it’s unlikely that anyone would accrue £5,000 in interest, even in today’s climate, it’s still handy to know that this interest can be utilised tax-efficiently.”
Pensioners can take advantage of the £20,000 tax-free ISA allowance.
This allows any interest earned on savings, dividend income, or capital growth from ISA investments to contribute to bolstering a pension fund, all without surpassing the tax threshold.
