Tax Erodes Pension Income by 30%

FUTURE PROOF: Despite a greater tax-free personal allowance after the age of 65, pensioners are seeing their income eroded by up to a third in retirement

Emma Wall 4 June, 2014 | 11:52AM
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Pensioners are seeing their income eroded by as much as 30%, with retired households paying £45.6 billion a year to the tax man.

According to calculations by the Prudential, income tax, VAT and council tax are the biggest bills for pensioners, averaging £6,400 a year per retired household.

On retiring, Britons are awarded an increase in their tax-free personal income allowance from £10,000 to £10,500 for those aged 65 or older, or £10,660 for those aged 76 and older. But for those pensioners who earn more than £27,000 a year, due to pension income, savings interest or a wage this personal allowance is   reduced by half of the amount - £1 for every £2 - you have over the £27,000 limit.

This means many pensioners who have been diligent savers during their working life continue to pay quite significant amounts of income tax.

“The changes to pensions and how people can take their retirement income announced in the Budget last month will provide savers and retirees with more choices and will affect the way that tax is applied,” said Stan Russell, retirement income expert at Prudential.

“Irrespective of these changes, the fundamental principles remain true – the best way to secure your desired level of retirement income is to save as much as possible as early as possible in your working life.”

Future Pension Plans

The pensions reforms outlined in the Budget were today featured in the Queen’s Speech, the last time the monarch will announce the proposed laws the coalition Conservative-Liberal Democrate Government hopes to pass before the May 2015 election.

Caroline Abrahams, charity director at Age UK, said that she welcomed the Government’s commitment to encouraging innovation in pension saving, including making it possible for Collective Defined Contribution pensions to be developed in the future.

The most radical of the reforms announced by George Osborne in March’s Budget was the decision to scrap compulsory annuity purchases, and hand back pension power to the individual.

According to stockbroker Hargreaves Lansdown almost two thirds of workers retiring this year have delayed buying an annuity because of the Budget and 80% of those retirees are waiting for further details to be confirmed.

“Retiring investors want clarity and certainty, both in terms of the rules governing their retirement income and in terms of their income payments themselves,” said head of pensions research Tom McPhail.

“This suggests reports of the annuity’s demise may have been greatly exaggerated. Some investors do now see drawdown as a more attractive option however it is not a risk free solution. We anticipate more and more investors will opt for a combination of an annuity to provide them with some security and a drawdown plan for flexibility.”

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Emma Wall  is former Senior International Editor for Morningstar