A quiet but significant shift has taken place in how pensioners are taxed.
In the 2021/22 tax year, only 494,000 pensioners paid income tax at 40 per cent or above.
That figure has now surpassed one million, and the total number of pensioners paying any income tax at all has risen from around 6.7 million to 8.8 million.
Unlike most tax changes, this has happened without a single announcement raising anyone’s tax rate due to the impact of fiscal drag from the frozen personal allowance rates.
Steve Webb, former pensions minister, revealed the new figures following a Freedom of Information request.
He has described how even a small rise in income can now push large numbers of people over the threshold at once.
A freeze with a long tail
Recent analysis suggests around 8.7 million pensioners currently pay income tax, with that figure likely to reach 10 million, equating to more than three quarters of all pensioners, by 2030/31.
With thresholds fixed and pension incomes rising each year in line with inflation and the continuing triple lock on the State Pension, more retirees are likely to cross into higher bands without making any active decision that caused it.
For anyone approaching retirement or already drawing a pension, this could impact their tax planning in the years ahead.
A pension pot that once looked comfortably within the basic rate band may no longer sit there by the time it is drawn.
Managing the impact
There are several ways pension income can be structured more tax efficiently.
Timing withdrawals carefully is one of the most effective tools available. As tax is calculated on income received within a tax year, drawing a large sum in one go, for a one-off purchase or house renovation, can trigger a higher rate charge that could have been avoided by spreading the withdrawal over two tax years instead.
Blending withdrawals from pensions, ISAs and other savings also gives more control over total taxable income each year, since ISA withdrawals are not taxed and can be used to top up income without pushing a pensioner into a higher band.
It is also worth checking whether pension contributions are still being made in earlier years before retirement, as tax relief on contributions can be more valuable for anyone who expects to become a higher rate taxpayer once they begin drawing an income.
Finally, anyone with a spouse or partner on a lower income should look at whether pension income, savings and investments could be held more evenly between them, since this can make fuller use of both people’s personal allowances and basic rate bands.
With thresholds frozen for several more years, the number of pensioners affected is only expected to grow. A proper review now can help avoid an unwelcome surprise later.
Get in touch with our team for a personalised review of your pension income and tax position.
