Working in retirement: the tax and pension implications
Since the default retirement age was scrapped in 2011, more people are opting to remain in work after 65. Some stay with their current employer full time, others move to a part-time schedule, while others become self-employed and start a new endeavour of their own.
YourMoney.com spoke to three experts about the key considerations for people who wish to work in retirement.
Whatever type of work you do, it’s important to remember any income you earn in retirement – whether it’s income from pensions (at home or overseas), employment or self-employment, dividends, bank/building society interest and some benefits – is taxable at standard rates. If you’re married, or in a civil partnership, you will pay tax on half the income received from jointly held assets.
However, you are no longer liable for National Insurance (NI) contributions in retirement, whether you continue to work or not.
Paul Evans, pensions technical manager at Suffolk Life, says you’ll need to provide your employer with proof of your date of birth (e.g. passport or birth certificate) if you opt to keep working.
“Failure to do so will mean you keep paying NI contributions when you’re not supposed to,” he says.
If you remain self-employed after reaching the state pension age, you will need to ensure your self-assessment tax return reflects this change, to avoid unnecessary NI payments.
If you decide to stay in work, you have various options in respect of your pension – whether state or private.
When you reach the age of eligibility for either, you can start taking them while continuing to work.
“Continuing to work while drawing the state pension is a good option for people who want to reduce their work commitments but don’t want to leave the workplace entirely,” says Deborah Morse, employment solicitor at Pantone LLP.
Alternatively, you can defer claiming your state pension until later. There are incentives for doing so.
“If you defer, you become eligible for a larger weekly sum when you do claim. As of April 2016, this will be equivalent to 5.8 per cent extra for each year you defer,” Morse explains.
“Alternatively, you can opt for a one-off lump sum payment when you claim, on top of the weekly payment. The lump sum is the value of the pension, plus the Bank of England base rate, plus 2%.”
Martin Tilley of pensions specialists Dentons, says retirees are often shocked by how flexible private pension regimes are, and the variety of tools available enabling them to use their pensions efficiently.
“These days, people rarely retire on a Friday, never to return. Work is phased out in stages, with the number of days worked per week reducing over time,” he says.
“The variable income you draw from your pension can accommodate this in a number of tax-efficient ways.”
On a basic level, drawdown can be used to bump up your income, and cover any shortfall resulting from the smaller number of days you work. This could be drawn from your tax-free lump sum. Tilley says there’s no need to withdraw the sum in its entirety at first; it can be accessed in individual chunks.
The pensions regime also supports accumulation. Those earning less than £150,000 a year get tax relief on contributions of up to £40,000 per year – although some schemes have cut-off limits, after which you cannot save any more, and are expected to start claiming.
Morse notes many pension schemes prohibit retirees from saving into their scheme if they are withdrawing from it. This is done to prevent ‘recycling’ – withdrawing the tax-free lump sum and recontributing it to a pension, gaining further tax relief in the process.
Some arrangements do permit you to pay into the same scheme, although the money will go to a different fund.
“This depends on who your policy is with, and your contract, so check with your provider,” Tilley says.
“You could choose to split your pension into different ‘sections’, drawing from some to ensure a sufficient income, and leaving others undrawn and growing.”
Tilley warns against accessing your pension unnecessarily.
“If you die before the age of 75 and haven’t accessed your pension yet, it is paid out in full to your nominated beneficiaries, completely tax-free,” he says.
“When you withdraw your pension, you move it into your personal estate – and those moneys become liable for inheritance tax.”
As a result, if you move into self-employment or part-time work and can survive on the income you receive, it may be sensible to postpone withdrawal until you reach 75.
“If you don’t need it, don’t draw it,” Tilley says.
There are, however, downsides to deferring.
“If you defer a state pension, you’ll miss out on almost £6,000 every year for each year you defer,” Morse says.
“If you defer a defined contribution scheme in the hope annuity rates improve further down the line, you risk rates not increasing – or rises not being substantial enough to make up for income you lost while waiting.”