Can I cut my income tax payments if I work and receive a pension?

16 December 2014

Q

I am currently employed full-time earning £20,000 a year and about to receive a pension from my previous employment on my 60th birthday, worth £13,500 each year. What can I do to reduce income tax payments?
From
WI/Essex

A

You pay income tax currently at the basic rate of 20% on your earnings. If you start to receive the pension as well, then the good news is that you'll not be pushed into the higher-rate income tax bracket.

However, as you're already using your annual income tax allowance, you will pay 20% income tax on all the proceeds you receive from the pension, with the possible exception of any tax-free lump sums that you might be paid.

Depending on the type of pension scheme you have from your previous employer, there might be scope to defer taking any income.

Of course, if you need the income this won't be helpful, although if you don't you may be able to defer receiving it until such time as you've stopped work. This would allow you to utilise your annual income tax allowance for a large proportion of your pension income and so you'll pay no tax on that amount.

However, if you can delay taking this pension you need to find out if there is a material benefit in doing so, in that you'll get a higher level of income in the future.

If this isn't the case, then delaying and paying less income tax now would prove to be a false economy. If you contact your pension scheme administrator, they can tell you if there is any flexibility in terms of taking income and how beneficial this would be.

You could potentially reduce the total amount of income tax you pay by making further pension contributions.

As a basic-rate taxpayer you will benefit from 20% tax relief on new contributions, effectively making a 20% income tax saving for you on these amounts.

There is a limit on how much you can save tax efficiently into a pension each year. However, you may need to be wary of Pension Commencement Lump Sum recycling rules that can limit the amount that can be invested in a pension if you've taken tax-free cash from your pension arrangements. Remember that 75% of your pension fund will be subject to income tax when you make withdrawals or start taking income from it.

While many people will want to reduce the amount of tax they pay, you should ensure that you don't do this at the expense of your standard of living by either forsaking income you need or spending money you can't afford to spend.

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