Tax planning tips for retirement

This current tax year will see 5.13 million retired pensioners paying some level of income tax, according to estimates from HM Revenue & Customs (HMRC). By comparison only 3.86 million pensioners were subject to income tax in 1996 / 97, when the Labour government came into power. Regardless of political agendas and the accelerating growth of an aged society, the mountain of tax waste appears to continue in ascendant.

According to IFA Promotion, British adults waste £7.6 billion a year on unnecessary tax, equating to around £155 per person. Mistakes can easily be made, both by the taxpayer and the Revenue; it is essential on retirement to maximise your income and ensure your affairs are as tax-efficient as possible.

Know your allowances

The personal allowance for the current tax year is £5,035, but it rises to £7,280 if you are in the 65-74 age bracket and to £7,420 if over age 75. This age allowance increment can easily be overlooked, particularly where women, who may currently retire at 60, are concerned.

Charity Tax Help for Older People notes that the Revenue often fails to switch people to the higher allowance automatically because it does not possess birth dates for all taxpayers. Apparently there is an alarmingly high level of incorrect tax codes. If you believe you're not getting your full entitlement in allowances, contact HMRC; also check out leaflet IRI21 Income tax and Pensioners, which explains the higher allowances.

Watch out for the clawback

If your retirement income is more than £20,100 (current tax year) you will lose £1 of the tax-free age allowance for every £2 of income over this limit, until you're back to the standard £5,035 personal allowance.

This income situation occurs at £24,590 for over-65s and £24,870 for over-75s. There is also the married couple allowance which maybe claimed if one of you was born before 1935. This gives relief at a fixed rate of 10%, but is not income that can be received without having to pay tax; it reduces the tax bill by 10% of the amount of the entitled allowance. Thus if both spouses are aged under 75, the tax bill could be reduced by £606.50 (10% of the basic married couple allowance of £6,065; if one party is over 75, the allowance increases to £6,135 in the current tax year).

Don't overpay tax

The first £2,150 of income above your personal allowance is taxed at 10%, yet with many types of income, higher amounts of tax can be deducted at source. For instance 20% tax is taken upfront from interest payable on bank and building society accounts and 22% tax from retirement annuities. Avoid this pre-taxed income situation, if you are a non taxpayer, by completing form R85, available from the annuity provider, bank or building society. To reclaim tax (possibly up to six years¹ worth) complete form R40, obtainable from your tax office.

Protect your savings

Obviously the imperative is to protect as much savings and investments as possible from the debilitating effects of income tax and capital gains tax. Don't make the mistake of having all or most of private pensions and savings in one partner's name, therefore utilising only one tax allowance.

Spread the load; if your spouse is a non-taxpayer or on a lower rate tax band transfer savings into their name and make use of their personal allowance. Note that not all types of saving are suitable if you are a non-taxpaying pensioner. For instance tax cannot be reclaimed on share dividends, nor on insurance products such as guaranteed income bonds.

It makes sense, if possible, to utilise your full ISA entitlement every tax year. Shelter £3,000 worth of your savings in a tax-free mini-cash ISA and £4,000 in a mini stocks and shares ISA; alternatively invest £7,000 in equities in a maxi ISA. ISAs, because the income is not subject to tax and is not counted as income for allowance purposes, can provide a possible way out of the age allowance trap.

This trap occurs when savings income falls between the lower and upper limits for age allowance purposes, effectively incurring a tax rate of 33% (basic rate of 22% plus 11% from the loss of the age allowance). If you are a higher rate taxpayer in retirement, also consider tax-free savings certificates from National Savings & Investments. The percentage paid when allied to the no tax element equates to a respectable return. Investing in growth-orientated funds can bring gains to supplement income, up to £8,800 worth free of capital gains tax in the current tax year.

Avoid inheritance tax

Finally, make plans to avoid inheritance tax (IHT) which snatches 40% of the value of your estate above £285,000 when you die. Give away assets where possible and practical, on the premise that gifts made at least seven years before death are not subject to IHT; if within that period the tax owed diminishes on a sliding scale basis. Apart from wedding gifts which are free of IHT (parents can give the bride and groom £5,000, relatives can chip in £2,500), £3,000 may be given away tax-free each tax year. If that latter amount is going to a charity, ensure it is done through Gift Aid so that the charity can claim all the potential tax relief.

14 July 2006 © Moneyextra.com

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