State Pension tax grabs – how your pot is affected and what you can do about it

Wasn’t it great 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?

If you’re mainly living off the state pension, you will have felt that was a victory for retirees. It will mean that pensioners will get around £11,500 a year on the full state pension from April 2024.

However, by raising the state pension while keeping the income tax threshold at £12,570, it means that the income boost to pensioners will push many of them into paying tax on it.

That’s if they have money from sources outside of the state pension that gives them an extra income of at least £1,000 a year. So the money was given with one hand and taken away with the other!

What is the triple lock, and how does it affect pensioners?

Back in 2011, the 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 Consumer Prices Index)
• or 2.5 per cent.

This year, the highest of those three, was average earnings at 8.5 per cent – a bit of a surprise at the time.

There was debate over whether the government would stay true to the triple lock and implement this increase. But they did, probably because they wanted to keep their core voters happy.

The decision will cost 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. That’s quite a sum for a country that is already horribly in deficit.

However, for pensioners it was great news. At least it seemed to be!

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.”

To find out how much, ideally, you should have in your personal pension pot – or other investments – see the information here.

When it comes to the state pension, right now, 12.6m people claim if and of that number, 53,444 are aged over 90.

• The average weekly state pension is £166.13 (women £156.35 vs £177.65 for men).
• However, the new state pension average will be £173.51 (women £170.61 vs £175.54 for men)

If you’re not sure what the state pension really is and how it works, find out here.

How does it affect ex-pat pensioners?

Abroad, 1.1m Brits claim the state pension while living in other countries, with an average weekly payment of £77.06. Many countries, where a ‘reciprocal agreement’ is in place, will honour the state pension increases enjoyed by UK retirees, so their state pension incomes will also rise in line with their UK counterparts.

However, where no such agreement is in place, including popular countries like Australia, Canada and New Zealand, the UK pension is frozen at the point the person leaves the UK.

What pensioners can do to cut their tax payments

There is not a lot pensioners can do to avoid paying tax on the higher amount they will be earning this year. However, depending on what your other investments are, there may be ways to reduce the tax you pay some of the time.

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.”

However, it’s worth remembering that that minimum income most people need for a just a basic retirement with no frills is about £12,800 for a single person. Even if you take more income each year, and pay tax on it, it’s likely to be worth it to give you more of a life.

The biggest challenge with taking income from a pension is that none of us really knows how long it may need to last.

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.”
 
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.

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!

Speak to friends and family to get a recommendation for a financial advisor, or look at Vouchedfor.co.uk which has lists of financial advisors who are rated by their other clients.

It’s also essential to get as much information yourself as you can about retirement planning, personal pensions and the state pension, and you can do that for free with the fortnightly MoneyMagpie investing newsletter. Sign up here and you could even win a cash payout.