Many retirees rely on income from a mix of pensions, investments, and property. While retirement may bring lifestyle changes, the tax rules remain the same as if you were employed. This means income from investments or pensions is taxed just like any other earnings.

If your total income exceeds £125,140, you’ll pay tax at the additional rate of 45%, whether that’s from a salary, dividends, or rental income. But there’s another tax trap lurking at the £100,000 mark, which could see you facing an effective tax rate of 60%.

Once your income goes over £100,000, you start to lose your personal allowance – the amount of income you can earn tax-free. For the 2024/25 tax year the personal allowance is £12,570. For every £2 you earn over £100,000, you lose £1 of your personal allowance, and by the time your income reaches £125,140, it’s completely gone. This means that the effective tax rate on income between £100,000 and £125,140 is 60%.

However, there are steps you can take to reduce your tax bill legally and ensure more of your hard-earned money stays in your pocket.

FIVE WAYS TO REDUCE THE TAX ON YOUR INVESTMENTS

1. Maximise tax-free allowances

No matter what tax bracket you fall into, any income you generate within an ISA is completely tax-free. You can contribute up to £20,000 into an ISA, which means a couple can shield up to £40,000 from the taxman each year.

If you have a £100,000 ISA and it generates 5% income annually, that’s £5,000 of tax-free income. You can also withdraw lump sums from your ISA to supplement your income, and you won’t pay a penny in tax.

2. Transfer investments to a spouse in a lower tax bracket

If you have investments outside of an ISA, and your spouse is in a lower tax band, you might want to consider transferring some of those assets to them. By doing so, they could pay tax at a lower rate on the income, or if they have spare ISA allowance, they can shelter the assets tax-free. No capital gains tax is due on transfers between spouses, making this an efficient way to reduce the overall tax bill.

3. Increase pension contributions

If your income has crept above £100,000, consider contributing to your pension. Pension contributions effectively reduce your taxable income, and this can help bring your income back under the £100,000 threshold, avoiding the 60% tax trap.

For example, if your income is £110,000, putting £10,000 into your pension would bring your taxable income down to £100,000, helping you keep your personal allowance. In 2024/25, the standard annual allowance for pension contributions is £60,000, though it reduces to £10,000 if you’ve already accessed your pension.

It’s worth double-checking that you don’t exceed your annual allowance and that you have enough earnings from employment or self-employment to make the contribution. Remember, you can only contribute up to the total amount of your earnings each year.

4. Consider capital gains over income

Investments that generate income are taxed at income tax rates, which can be as high as 45%. However, if you focus on investments that generate capital gains, you’ll likely pay less tax. For example, an additional rate taxpayer would pay 45% tax on income but only 20% on capital gains (or 24% for property).

Everyone has a CGT-free allowance, which for 2024/25 is £3,000 per person. While this has been reduced from previous years, it still provides an opportunity to cut your tax bill by favouring investments that deliver capital growth over income.

5. Take Advantage of other tax breaks

Beyond ISAs and pensions, there are other tax-efficient strategies that can help reduce your taxable income. For example, you can make use of charitable donations or explore tax-advantaged schemes like the EIS (enterprise investment scheme) or VCTs (venture capital trusts), both of which offer significant tax reliefs on income and capital gains.

With careful planning, retirees can make the most of these strategies to manage their income, shelter their investments, and minimise the amount of tax they pay. It’s all about understanding the rules and taking advantage of the options available to you.

By adopting these strategies, you can ensure that you’re making your retirement savings work as hard as possible, while keeping the taxman at bay.

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