With around 400,000 more pensioners set to be hit with an Income Tax bill next year, we reveal four ways you can reduce or delay the 'retirement tax'.
On the face of it, there was good news for UK retirees this week after it was revealed that the State Pension could jump by more than £500 next year.
As a result of the triple lock, pensioner pay must rise by the highest figure out of wage growth in the three months to July, inflation as determined by the Consumer Price Index in September and 2.5%.
Wage growth seems likely to be the deciding factor in the next calculation, with this data becoming available in September. Barring any surprises in July's figures (which are not yet processed), it is expected to come in around 4.5%.
If correct, this would see full State Pension pay rise from £221.20 a week to £231.15.
That works out to an annual increase of £517, taking total pay to £12,061 a year.
While this boost would no doubt be welcome for hard-pressed retired households, there is a sting in the tail as it will likely see 400,000 more paying the 'retirement tax'.
Here, we explain exactly what's happening – and what you can do to either avoid, or at least delay, an increased tax bill.
Read about the different types of State Pension in our comprehensive guide
Soaring number of pensioners paying tax
It all comes down to the Government freezing the amount of money we can earn tax-free.
This Personal Allowance has been frozen at £12,570 since 2021 and will remain in place until 2028 at least (there are rumours the new chancellor will look to extend it further still).
As a result, many more pensioners are being forced to pay what critics of the Government are calling a 'retirement tax', as even those with minimal income from personal pensions are forced to pay a tax bill for the first time.
Remarkably, with the State Pension rising each year thanks to the triple lock, it's on track to exceed the Personal Allowance in 2026 meaning every retiree on the full New State Pension will be paying tax by that time.
The harsh reality is many more pensioners are going to face bigger tax bills in the years ahead, but there are at least some steps they can take to minimise the impact.
Here are four ways pensioners can shelter as much of their income as possible from this stealth tax raid.
1. Defer your State Pension
If you have another source of income, you could consider deferring your State Pension to reduce your tax liability.
Contrary to what some people believe, there is no requirement that you start claiming your State Pension as soon as you become eligible for your payments.
As you approach State Pension age, you should receive a letter telling you what to do if you would like to begin claiming your pension.
If you decide to defer, you don’t need to do anything at all.
Bear in mind that deferring your pension will result in an increase to your payments when you do finally claim.
For every nine weeks you defer, your payments will rise by 1%.
While higher payments are theoretically a good thing, this could push you closer to the Income Tax threshold when you do start to claim.
Learn more in our guide to deferring your State Pension
2. Maximise your ISA savings
Whatever your age, ISAs should always be your first port of call if you would like to reduce your taxable income.
Under current rules, these products allow you to stash up to £20,000 per year in tax-free savings.
At present, the main types of ISAs available to those over State Pension age are Cash or Stocks and Shares ISAs.
Cash ISAs can be instant access, fixed rate or notice accounts (requiring you to let the provider know in advance if you intend to make a withdrawal). Meanwhile, Stocks and Shares ISAs are for those comfortable with some risk as it allows tax-free investing in the stock market.
There's also a lesser-known Innovative Finance ISA, which lets you invest in peer-to-peer lending and earn tax-free interest.
Finally, there's the impending British ISA, which will allow you to invest an additional £5,000 per year in UK assets.
The Government has yet to announce a launch date, and it's unlikely to be before April 2025.
How to become an ISA millionaire
3. Use the Starting Rate on savings
All UK taxpayers currently have a Personal Allowance that enables them to earn up to £1,000 in savings interest before they start paying tax.
The Starting Rate provides an additional allowance of up to £5,000 for those on a low income.
Be aware, however, this is a tiered perk.
If you earn under the Basic Rate Income Tax threshold (£12,570) from your pension or employment, you’ll receive the full tax-free allowance of £5,000.
Those earning between £12,570 and £17,570 will still qualify for tax relief on their savings interest – although you’ll lose £1 of your allowance for every £1 you earn above £12,570.
If you’ve overpaid on savings income in previous tax years, you can reclaim this money by filling in a Self Assessment form with HMRC or completing form R40.
As well as the current tax year, you can claim for any underpayments during the past four years.
4. Claim the Marriage Allowance
Having been introduced in 2015, this allows the lower-earning member of a couple to transfer any unused portion of their Income Tax allowance to their spouse or civil partner.
Lower-earning partners can transfer up to £1,260 every tax year, which equates to a saving of £252 for the 2024/2025 tax year.
You can also backdate your claim to 2020, which could mean additional savings.
Once you’ve claimed the allowance, the transfer will automatically continue every year until the marriage ends (either by death or divorce).
If you do wish to cancel the transfer in other circumstances, you’ll need to inform HMRC directly.
Be aware, this perk is exclusively for those who are married or in civil partnerships and cohabiting couples won’t qualify.
Hundreds of thousands of pensioners at risk of tax shock
This article does not constitute financial advice. Consider speaking to an advisor before making any decisions regarding your retirement plans.