There is no doubt that your tax position is likely to change once you start to take retirement, and it is vital that everyone reaching retirement age should invest some time in understanding how the tax system applies to them. The most common types of tax are income tax, National Insurance contributions and capital gains tax (CGT), all covered in this chapter, and inheritance tax (IHT), which you’ll find in Chapter 15.
In general, the tax burden on households is currently increasing. This is not because rates are rising, but because most allowances and thresholds have been frozen – or in some cases cut. Freezing allowances and thresholds causes ‘fiscal drag’ meaning that, as your income rises with inflation, you end up in a higher tax bracket than previously even though your standard of living (after taking account of inflation) has not necessarily improved.
Income tax – the basics
This is calculated on all (or nearly all) of your income, after deduction of the personal allowance (which most people get). The reason for saying ‘nearly all’ is that some income you may receive is tax-free (see below). Having deducted the personal allowance, what remains is the income on which tax may be due.
Most income counts. You will be assessed for income tax on your pensions (including your State Pension), interest you receive from most types of savings, dividends from investments, any earnings from a job (even if these are only from casual work) and profits from being self-employed, plus rent from any lodgers, should the rent you receive exceed £7,500 a year. However, there are other allowances that may reduce or eliminate the tax you pay on savings income, dividends and very small business ventures. Many state benefits are also taxable.
You may pay less income tax if you have some types of expenditure that qualify for tax relief – these are sometimes called ‘outgoings’. The most common outgoings that qualify for relief are payments you make to a pension scheme and donations to charity.
Income tax is an annual tax. The tax year runs from 6 April to the follow-ing 5 April, so the amount of tax in any one year is calculated on the income you receive (or are deemed to have received) between those dates.
Personal allowance
You don’t pay tax on every single penny of your money. Most people are allowed to retain a certain amount before income tax becomes applicable. This is known as your personal allowance. It does not matter where the income comes from, whether from earnings, an investment, a pension or another source. The personal allowance is given automatically; you do not have to claim it.
The personal allowance for 2023/24 is £12,570 and is frozen at this level until April 2028.
Not everyone gets the personal allowance. For people with income of more than £100,000, their personal allowance is reduced: £1 of allowance is lost for every £2 by which their income exceeds £100,000. This means that in 2023/24, someone earning £125,140 or more does not get any personal allowance.
Rates of income tax
What’s left of your income after subtracting your personal allowance is divided into slices, called tax bands, and different rates of tax apply to each band. Scotland has different tax bands and rates from the rest of the UK. Wales also has the power to set its own Welsh income tax rates, but in 2023/24 has chosen to set these at the same level as the rates for England and Northern Ireland. The four different rates of income tax for 2023/24 for the UK apart from Scotland are:
1 The 0% savings rate, which applies to the first £5,000 of any taxable sav-ings income. However, if an individual’s taxable non-savings income ex-ceeds the savings rate limit, then the 0% rate for savings will not be available for savings income.
2 The 20% basic rate for taxable income up to £37,700 (frozen until April 2028).
3 The 40% higher rate, which is levied on all taxable income from £37,701 up to £125,140 (was previously £150,000).
4 The top rate of 45% on income in excess of £125,140.
Different tax rates apply to dividend income, and these are described later in the chapter.
Scottish income tax
Scotland has the power to set its own tax bands and rates of tax for all types of income, except savings income and dividends – for these, the UK rates described later in this chapter apply. Scotland must also have the same personal allowance as the rest of the UK. Scottish income tax applies if your only or main home is in Scotland. Your tax is still collected by HMRC on behalf of the Scottish tax authority, Revenue Scotland.
Scotland charges less tax than the rest of the UK on lower incomes, but more on higher incomes. In 2023/24, it does this through a system of five tax bands:
1 a 19% starter rate on the first £2,162 (in excess of your personal allowance) of income from pensions, earnings, rents and so on;
2 a 20% basic rate on taxable income from £2,163 to £13,118;
3 a 21% intermediate rate on taxable income from £13,119 to £31,092;
4 a 42% higher rate on taxable income from £31,093 to £125,140;
5 a 47% top rate on taxable income over £125,140.
Welsh income tax
Since April 2019, Wales can set its own Welsh income tax rate for all types of income, except savings income and dividends – for these, the UK rates described later in this chapter apply. Wales must also have the same personal allowance as the rest of the UK. If you live in Wales, you count as a Welsh taxpayer (even if you work over the border in England or elsewhere).
The way Welsh income tax works is that the normal UK rates are reduced by 10% – so the UK basic rate becomes 10% instead of 20%, the higher rate becomes 30% instead of 40%, and the additional rate becomes 35% instead of 45%. The Welsh Assembly can then add a Welsh income tax rate on top of these reduced UK rates. For 2023/24, the Welsh rate has been set at 10% for all the tax bands. This means you pay the same total tax rate as taxpayers in the rest of the UK except Scotland. Your tax is still collected by HMRC, and the Welsh part is passed to the Welsh Revenue Authority.