You need to make changes to protect your money (Image: GETTY)
As the state pension rises, even more pensioners are being dragged into paying income tax thanks to the frozen personal allowance. Others are being dragged into higher-rate 40% and additional-rate 45% tax bands, and handing an ever-larger slice of their retirement income to HMRC.
With Chancellor Rachel Reeves extending the tax threshold freeze to 2031, they will pay more year after year. But with careful planning, pensioners can fight back and potentially save thousands of pounds. Here’s what you need to know.
Read more: DWP £5,000 warning to pensioners
Read more: Anyone with a pension told of 4 key changes in 2026 including new ‘£1,000 rule’
Pensions:
The state pension is the bedrock of most people’s retirement income, and the good news is that it will rise in line with the triple lock next April at 4.8%. That will lift the full new state pension to almost £12,548, which is only £42 below the frozen £12,570 personal allowance.
Any retiree with even the tiniest sliver of extra income will start paying tax on it.
From April 2027, everyone receiving the full new state pension will exceed the personal allowance entirely.
Chancellor Rachel Reeves has suggested pensioners won’t have to pay income tax if they have no other sources of income, but the devil is in the detail and we don’t know it yet.
One thing is clear, though. More than nine million pensioners already pay income tax in retirement, and that number is only heading higher. So minimise what you are charged wherever possible.
The 25% tax-free cash lump sum benefit survived the Budget, despite feverish speculation that it was doomed.
Any withdrawals above that count as income and may trigger an income tax bill, so you need to plan carefully.
Spreading them over several years rather than taking one huge lump sum can save serious money, especially if it prevents you tipping into a higher tax bracket.
Think twice before raiding your pot too soon. You can start withdrawals from age 55, rising to 57 from 2028, but drawing a pension while still working can result in a painful tax hit.
Draining too much too early also risks leaving yourself short later in life.
Rachel Vahey, head of public policy at AJ Bell, warns savers to be cautious with their tax-free cash. “You will be removing it from an environment where it can grow tax free, so think long and hard about what you want to do with the money.”
She adds: “If it languishes in a bank account, it could be losing out on valuable tax-free growth at the very time you need it most.”
Another hazard is the little-known money purchase annual allowance (MPAA). Once you take taxable income from your pot, you can only contribute £10,000 a year back into a pension, including a workplace scheme.
Andrew Tricker, director at Lubbock Fine Wealth Management, says too many of us stumble into it unawares. “Triggering the MPAA can drastically reduce what you can contribute to a pension moving forward, catching many out,” he says.
A brand new threat lands in April 2027, when Chancellor Rachel Reeves imposes inheritance tax on unused defined contribution pensions for the first time.
These pots were previously IHT-free, making them a popular way of passing wealth to loved ones while spending down other assets such as ISAs. That advantage will soon evaporate.
Families may need to rethink their plans. That could include gifting money earlier in life, though that brings its own risks if you later have unexpected spending needs or social care.
Gary Smith, financial planning expert at Evelyn Partners, says the patchwork of IHT gifting rules can be tricky to navigate so consider advice. “The annual small gifts allowances won’t make much of a dent, so consider making larger gifts under the seven-year rule, known as ‘potentially exempt transfers’,” he adds.
For others, reviewing whether to stay in drawdown or shift into an annuity could help manage IHT exposure.
Some may even consider whole-of-life insurance to cover a future IHT bill, though premiums must be maintained for life.
Planning ahead is essential. With frozen thresholds, rising pension incomes and changing rules, the price of getting it wrong is climbing fast.
How to minimise tax on your savings:
Pensioners got some rare good news in the recent Budget, as they can still shelter £20,000 a year in a Cash ISA, while the under-65s will be restricted to £12,000 from April 6, 2027. Older savers typically prefer the comfort of guaranteed, tax-free interest rather than risking their capital in the stock market, even if shares can produce a superior long-term return.
Most also benefit from the personal savings allowance (PSA), which lets basic-rate 20% taxpayers earn £1,000 of interest a year tax-free. That falls to £500 for higher-rate 40% taxpayers and nothing at all for 45% additional-rate payers.
Those rates have been frozen since the PSA was launched in 2016, while interest rates have risen strongly, and today more than a million pensioners pay income tax on their savings interest.
Jeremy Cox, head of strategy at Coventry Building Society, highlighted some less good news in the Budget, as Reeves introduced a new tax surcharge on savings interest, which will increase the tax bill for anyone exceeding their PSA.
“From April 2027, basic-rate taxpayers will pay 22% on interest over £1,000, while higher-rate taxpayers face a steep 42% on interest above £500,” he says. “Additional-rate payers face a 47% charge.”
Cox highlights another threat. “As income tax thresholds remain frozen, more savers risk entering higher tax bands where their PSA will be cut, exposing them to that 2% surcharge.”
All of which makes using your ISA allowance crucial if you can afford it. The £20,000 annual limit gives all savers a chance to lock in tax-free interest for life.
For those with larger pots, Premium Bonds offer another tax-free option, allowing up to £50,000 per person. Winnings are entirely tax-free but unreliable, so anyone who needs predictable income should steer clear. More sophisticated savers might consider other tax-efficient routes, such as investing in gilts, but these can be complex and usually require advice.
Whatever you do, never settle for a dud rate, says Anna Bowes, personal finance expert at The Private Office. “As ever, shop around for the best rate and remember you can transfer older Cash ISAs across to a new account, if the interest rate dwindles.”
Capital gains tax:
Capital gains tax (CGT) used to be called the forgotten tax, but investors who get caught out will have good reason to remember it. CGT is charged on profits made when selling assets such as antiques, jewellery, cryptocurrency, stocks and shares held outside the tax-free ISA wrapper. It also applies when selling a business.
You don’t pay CGT on the full sale price, only on the increase in value since you acquired the asset. While your main home is exempt under private residence relief, CGT is charged on sales of second homes and investment properties. In her maiden Budget in October 2024, Reeves hiked CGT to a flat 18% for basic-rate taxpayers and 24% for higher-rate taxpayers.
Former Conservative Chancellor Jeremy Hunt previously slashed the annual exempt amount from £12,300 to just £3,000, making CGT a bigger threat than ever.
Rachael Griffin, tax and financial planning expert at Quilter, says landlords can reduce their bill by using the annual exempt amount and offsetting initial purchase costs.
Estate agent and solicitor fees, stamp duty paid on purchase, and surveying or valuation costs can all be deducted.
They can also claim for improvement works such as a garage, conservatory or extension, or upgrading kitchens and bathrooms. In every case, receipts must be kept.
Jason Hollands, managing director at Bestinvest, says married couples and civil partners can reduce their exposure by transferring assets between themselves free of CGT, doubling their £3,000 exemptions.
They can further cut CGT by putting assets into the name of the partner in the lower tax band. Otherwise, invest inside your £20,000 tax-free ISA allowance, where all returns are free of income tax and CGT.
Those who hold shares outside an ISA can sell them and buy them back within the tax-free wrapper, a process known as Bed & ISA.
“Just remember you may face a tax liability on the sale, but you could reduce this by spreading the initial sales over several tax years,” Hollands adds.
Dividend tax:
Rachel Reeves also hiked dividend tax bands by 2% in the Budget, in a move that will hit investors with shares held outside of an ISA, and limited company directors who take income as dividends. Around 3.6 million people already pay dividend tax, and more will be dragged in as allowances shrink and rates rise.
The basic rate will jump from 8.75% to 10.75% in April, while the higher rate will climb from 33.75% to 35.75%. The additional rate stays at 39.35%.
Jeremy Hunt had previously slashed the tax-free dividend allowance from £2,000 to just £500 today. Anyone earning more than that may owe dividend tax, unless their total income is below the £12,570 personal allowance. Older savers who rely on dividends from shares held outside tax shelters are among those most exposed.
Small company directors and freelancers who take part of their income as dividends will also feel the impact.
One defence is to shift shares into an ISA, where dividends are completely tax-free and need not be declared. Be aware that selling shares first may trigger capital gains tax, especially with the annual CGT allowance cut to £3,000.
4 point checklist before end of tax year
The end of the tax year on April 6 is looming, and it pays to start planning now so you’re ready for it. Kwasi Yeboah, chartered financial planner at advisory group Saltus, has produced the following checklist. “Early planning maximises tax efficiency and protects your savings,” he says.
Use your ISA allowance: Put in the full £20,000 if you can. Choose the type that suits your goal – Cash ISA for low-risk saving, Stocks and Shares ISA for longer-term growth, Lifetime ISA for first-home or retirement, and Junior ISA for children. Couples should each use their allowance to protect £40,000 from tax.
Make the most of capital gains tax allowances: Review investments and assets. Sell holdings up to the £3,000 allowance to realise gains tax-free. Transfer assets to your spouse to double the allowance and, if possible, shift assets to the partner in the lower tax band to reduce CGT. Consider a “Bed & ISA” to move investments into tax-free ISAs.
Boost your pension contributions: Maximise your contributions to benefit from tax relief at your marginal rate. Carry forward unused allowances from the previous three years if possible. If employed, ask about increasing workplace contributions – especially if your employer matches them. Self-employed? Make contributions through your company to reduce corporation tax. Avoid the 60% tax trap: If earning between £100,000 to £125,140, make additional pension contributions or Gift Aid donations to restore your personal allowance and cut your tax bill.
Plan for inheritance tax: Use your £3,000 annual exemption and £250 small gifts. Gifts out of surplus income can reduce your future IHT liability.
Consider IHT implications for pensions from April 2027. Check dividends and savings: Shift shares into an ISA to shelter dividends from tax.
Use your Personal Savings Allowance for interest, and review high-risk tax-efficient schemes like EIS, SEIS, or VCTs if you’ve maximised other allowances. Get advice first.