This article is written by

Steve Elliot

Amber River West Midlands

Find out more about Steve and his West Midlands team

Amber River West Midlands

You’ve already done the hard part. You’ve spent years building up your savings to enjoy a comfortable retirement. But unless you’re careful, you may be paying more in tax than is necessary.

While you should never base investment decisions solely on tax efficiency, there are several ways to reduce your tax bill in retirement. With a combination of the following options, you may be able to save thousands in tax every year, helping you to make the most of your retirement:

You may be able to save thousands in tax every year

  1. Draw a tax-free lump sum from your pension. This is usually 25% of the fund value, although it may be calculated differently for specific occupational schemes.
  2. Phase your pension tax-free lump sum over a number of years, rather than drawing it all at once. Funds invested within a pension benefit from tax-free growth on interest and dividends. This will keep more of your money within the tax-efficient pension wrapper for longer.
  3. Draw an income from your pension up to the value of the personal tax-free allowance (£12,570 for 2020/2021). This means that you won't pay any tax on your pension income. This option works best if you have cash and investments to use to top up your income.
  4. Defer drawing on your pension for as long as possible, for example, if you have other income that already uses up your allowances. This allows your pension fund to benefit from tax-free growth for longer.
  5. Invest up to £20,000 every year in an Individual Savings Account (ISA). Growth, interest, and dividends from investments in an ISA are all tax free.
  6. Use savings in an ISA for significant one-off purchases. ISAs give you the flexibility to hold and withdraw more for one-off expenditure items than from a pension or investment account, which can result in substantial tax implications.
  7. Make use of your Capital Gains Tax (CGT) allowance each year (currently £12,300 for an individual) to avoid large gains rolling up later on.
  8. Structure your investments depending on the type of income they generate. You can receive dividends of up to £2,000 per year without paying tax. Therefore, it can be beneficial to hold dividend producing assets in a taxable portfolio, like a General Investment Account (GIA), while holding interest-bearing assets in an ISA.
  9. If your spouse has an income of less than the Personal Allowance (currently £12,570), transfer more of your income-generating investments to them to make use of both personal allowances.
  10. Hold assets jointly before selling them to make use of both CGT allowances. Transfers between spouses are ignored for CGT purposes, and there is no minimum holding period.
  11. Consider the impact that any inheritance you are still yet to receive will have on your estate plan. It may make sense to skip a generation and pass that inheritance directly to your children.

As a golden rule of thumb, cash is used first, followed by taxable investments, ISAs and then pensions

The most efficient retirement income strategy is planned well in advance and, for married couples, planned together. Planning in advance means you can make full use of your allowances and exemptions. Planning as a couple means you can ensure that your income and assets are allocated effectively.

As a golden rule of thumb, in terms of capital withdrawals, cash is used first, followed by taxable investments, ISAs and pensions. A financial plan can help you structure your income, reduce your tax in retirement and enable you to achieve your goals.

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