Five Tax Traps to Avoid in Retirement

Tax Traps to Avoid in Retirement

Who doesn’t look forward to a time when all days in the week can be spent doing leisurely activities? For a truly enjoyable retirement, you have to make sure all your affairs are in order early on. To ensure that happens, here are some traps to avoid.

1. Forgetting to take the lifetime allowance into account

If your pension will be more than £1m by the time you retire, you have to be aware about the Lifetime Allowance (LTA).

For 2018/19, the government increased the LTA to £1.03m from £1m in 2017/18. Any amount saved exceeding the set limit is subject to a hefty UK tax charge. The amount will also increase each year

It is a one-off charge that can be paid through the following means:

  • 25% as pension
  • 55% as lump sum, or
  • a combination of both

You can avoid exorbitant tax charges on savings by closely monitoring your pension so you don’t exceed the LTA. Another option is to apply for protection, but you can only do this if you haven’t taken any pension benefits.

In addition, if you have paid too much tax, you are entitled to a UK tax refund. Keep in mind that HMRC will not send a tax return if they think you are paying the right amount of tax through the PAYE system.

2. Failing to maximise contributions

The standard pension allowance is the amount you or your employer can put into your pension without having to pay a tax charge. While that amount remains at £40,000, higher income earners will see that amount tapered. That means, annual allowance will be subject to a £1 deduction for every £2 of adjusted income that is over £150,000.

Income doesn’t just refer to salary. This includes bonuses, dividends, employer pension contributions, and income earned from a buy-to-let property – just to name a few.

You can avoid paying tax on pension contributions by taking advantage of the “carry forward rule.” This is how it works: you can pay more than the standard allowance if you have unused allowance from the three previous tax years.

But in order to qualify for the “carry forward” rule, you need to have been a member of any registered pension scheme in the years you are carrying forward.

3. Relying solely on pensions

There are several investment vehicles – tax-efficient options at that – those you can turn to in addition to your pension. Individual Savings Accounts is one, life insurance bonds is another. You can also look into Enterprise Investment Scheme reliefs or Venture Capital Trusts.

4. Failing to find ways to reduce inheritance tax

Inheritance tax (IHT) is to be paid six months after death. You can reduce the amount due through several means, including paying into a pension. Given that the pension was set up in the right way and took recent rule changes into account, it will be received by whoever inherits it tax free if you die before the age of 75.

On the other hand, death after 75 means the beneficiaries will pay a marginal rate when they tap into it. You can look into other assets that are vulnerable to IHT to finance your retirement.

5. Neglecting to give away assets

Another way to reduce IHT is to give away assets. Up to £3,000 can be given each year as a gift, IHT free. In addition to that, you can give away £250 annually.

As you give away assets, make sure that doing so doesn’t affect your standard of living.

Translate »