Record numbers of us are working after retirement age, but what are the rules? How does it affect our pensions and how much tax we pay? With prudent planning, it could be less than you think.
The meaning of the word retirement has changed beyond recognition and no longer describes what life looks like today for those of us who are over 60. Many of us now want an extended or phased transition from the 9 to 5 and fear missing out on the mental stimulation and social engagement work offers.
Working after 70
Whether you embrace your late 60s and 70s in full or part-time work, or you become self-employed, you’ll have tax and pension decisions to make. If in doubt, you could take advantage of our free online guidance – you don’t even need to have a pension with us. Or you could make an appointment with one of our qualified financial advisers.
Alistair Mcqueen, Head of Savings & Retirement at Aviva, says more people are working beyond the traditional age of 65. It's a trend he expects to continue.
“There are two levers most of us can pull to fund our later life: we can save more or we can work longer. Many will pull both,” he adds. “When preparing for retirement, or in retirement, remember that it's not all just about saving. Working is also one of the most powerful actions we can take. More and more people, and employers, are rising to this opportunity.”
How to keep your tax bill down
Let’s look at the practical steps you can follow to keep your tax bill to a minimum when drawing from a defined contribution pension while working.
The simplest way is to take only the amount you need in each tax year from your pension as the lower this is, the less tax you pay.
While you can take all your pension pot as a lump sum from the age of 55 (57 from 6 April 2028 unless you have a protected pension age) this could leave you with a large tax bill. If you carry on working, it could make sense to keep your money in your pension. If you have a defined contribution scheme, this is where it can be an advantage to use flexible drawdown, which lets you vary your income from year-to-year in a tax-efficient way.
Tax benefits are subject to change and individual circumstances.
Remember though, that if you take flexible drawdown, the rest of your pension remains invested and its value can go down as well as up, so you may get back less than has been paid in. There's no guarantee that it will last for the whole of your retirement. This will also affect the amount that you can pay into a defined contribution pension each year.
Ease into semi-retirement with phased drawdowns
If you’re planning to semi-retire or opting for a part-time job, you could use the tax-free 25% of a defined contribution pension in phased drawdowns to cover the drop in your earned income. This will allow you to minimise your tax bill during these years and make the most of your tax-free allowances as you relax into retirement.
Whether your pension is a defined contribution or a defined benefit scheme, the unavoidable reality is that income from it (apart from the 25% tax-free element) is taxed like all other earnings.
For this reason, your tax-free Personal Allowance of £12,570 for tax year 2024/2025 is important. Once you earn between £12,571 and £50,271, you pay the basic 20% tax rate. The 40% bracket covers £50,271 to £125,140 and for income above £125,140, you pay 45%.
For the current 2024-25 income tax bands and rates in Scotland, please see income tax in Scotland for more information.
Avoid unnecessary withdrawals
To be tax savvy with a defined contribution scheme, you need to be strategic about your withdrawals from the taxable 75% portion of your pension pot. If you can, spread them throughout the year, and over a number of tax years, so you can benefit from your tax-free allowances. Avoid unnecessary or large one-off withdrawals that could tip you into a higher tax bracket.
Bear in mind, if you’re still working, your salary plus pension withdrawal may push you into a higher tax band than if you just took the tax-free amount on its own.
Remember that your income stops when the money in your pension runs out and the more money you take, the more likely it is that your pension will run out faster.
Money you get from your pension is looked at when working out your entitlement to any state benefits. Taking any withdrawals may affect the benefits you can receive.
Benefit from tax-free boosters
ISAs are exempt from Capital Gains Tax and Income Tax, which makes your withdrawals tax-free. If you have money in a cash or stocks and shares ISA, you could consider using this first, to reduce the amount of taxable money you need to take from your pension.
This isn't guaranteed to be a sustainable option, though. With a stocks and shares ISA, investments can fall as well as rise, so you could get back less than you put in. With a cash ISA, growth may not keep pace with inflation
Collecting your State Pension
With personal pensions you can normally access your money once you turn 55 (57 from 6 April 2028 unless you have a protected pension age). The State Pension age is currently 66, rising to 67 between 2026 and 2028.
Currently worth £11,502.40 a year, your State Pension can be an important addition to retirement income (providing you’ve paid 35 years’ worth of National Insurance contributions). You should therefore check when you can claim.
If you’re working after your pension age, another useful way to limit unnecessary tax, and boost your income down the road, is to delay taking your State Pension. For each year you defer, you’ll get an increase of around 5.8%.
Just be aware that deferring only really pays off around nine or 10 years after you decide to take it.
