How to pay less tax on your retirement income
For most people there’s no escaping tax in retirement. But with advice and planning, it’s possible to reduce its impact on your retirement income.
Retirement planning
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The World Economic Forum has predicted many of us will outlive our money by at least a decade after conducting a major study into the impact of our increasing longevity. For women this issue is of even greater concern.
Women tend to live over four years longer on average than men1 which means they need to save more money for retirement. Adding to these saving pressures, women are also more likely to have gaps in their employment history and are at the losing end of pay inequity. The result is a shocking 35% gender pension gap in the UK.2
But how realistic is it that many of us will live to see our hundredth birthday?
Research predicts that children born today will have a 50 percent chance of living to age 100 and almost one in five women aged 25 today will reach their centenary year.3 But it’s not just the young who need to consider such a long lifespan. The Office for National Statistics estimates that a woman who has already reached the age of 65 will have a 7.4 per cent chance of reaching 100.
As we live longer, healthier lives we clearly need to reappraise our financial futures and recognise that our savings and investments may have to support us and our lifestyles for 35 years or longer.
In their book, The 100-Year Life: Living and Working in an Age of Longevity, Lynda Gratton and Andrew Scott put this issue in stark perspective. “The simple truth is that if you live for longer then you will need more money. This means either saving more or working for longer.” The expectation that retirement will start early-to mid-60s is likely to be a thing of the past, or a privilege of the very wealthy.
Inadequate savings rates
Understanding how much we will need to maintain a comfortable and financially stress-free retirement is key. To support a reasonable level of income in retirement, The World Economic Forum Report suggests we need to be saving 10%-15% of our annual salary. Today, individual savings rates in most countries are far lower. This is already presenting challenges where traditionally defined benefit structures would have previously provided a guaranteed pension benefit.
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High degree of individual responsibility to manage a pension
The popularity of defined contribution systems has been growing steadily over the past few decades and the way that these plans are designed puts a high level of responsibility on individuals to manage their retirement savings. Unless they have the support of a wealth management firm like Investec Wealth and Investment (UK), this can include deciding how much to save each year, which investments to choose, how long they are likely to live, when they should retire, and how to withdraw their savings when they do decide to retire full-time. The information reported to individuals often doesn’t make it easy to make informed decisions to try to meet a target level of retirement income. For example, the account balance does not help individuals understand what they would likely receive as a monthly income and the investment return achieved does not help determine whether to increase savings rates, stay employed longer and delay retirement or take more investment risk.
The impact of inflation is also a major factor. To put its potential impact into context, if someone today needed £100,000 to meet their current standard of living, in 15 years’ time they would need £180,000 based on the long-term average rise in the cost of living of around 4%.4
How people approach the challenge of ensuring they don’t run out of money in later life will vary considerably, but below are some simple ways that can help.
- Save more and save earlier in life and benefit from the power of compounding. Someone investing £5,000 p.a. at an average 5.5% growth rate from age 20 would have a portfolio worth £838,426 if they retired at 65. Conversely, using the same amount and growth rate, but starting at 45 years of age would result in a retirement pot of just £173,596.
- With pension freedoms giving us easy access to our retirement savings, it’s crucial we try to avoid dipping into them too early.
- Once you’re actively drawing down an income from your investments, make sure you review your funds and withdrawal strategy at least twice a year. If the value of funds has declined or is below the growth you anticipated, then you might need to think about reducing the income you take.
- Talk to us about cashflow modelling. This process makes several assumptions based on your likely spending patterns, potential income, and factors like inflation. It’s not a guarantee of how things will pan out, but it will give you a good sense of the lifestyle you can achieve and can also help provide clarity on the most tax-efficient way for you to take an income in retirement. For more information on this topic please read our article: Avoid these mistakes to sustain your lifestyle in retirement.
- Seek advice on the most effective way to take an income in retirement. With the right planning your retirement income may potentially stretch further. For more information on this topic please read our article: How to pay less tax on your retirement income.
But it’s not just our finances we should be thinking about. Living to 100 unlocks a world of new possibilities and new perspectives of how we can live our lives. Life expectancy has increased by over 30 years since the UK state pension was introduced in 1908, yet our societally perception of the age we should retire has barely changed.
Many of us have been raised on the traditional notion of a three-stage approach to our working lives: education, followed by work and then retirement. But this well-established pathway is rapidly changing as life expectancy rises, final-salary pensions are vanishing, and increasing numbers of people are juggling multiple careers. Whether you are 18, 45 or 60, many of us will need to do things very differently from previous generations and learn to structure our lives in completely new ways.
Today we no longer need to follow the linear career paths many of our parents felt stifled by, and instead we can build vibrant lives that fit us better. And with the prospect of working up to a decade or two beyond previous generations - the mirage of retirement makes it feel even more urgent to find a model that is fulfilling and sustainable for the long haul.
The term ‘Portfolio Living’ captures this idea of no longer seeing ourselves as locked into the social cliches of being someone who is either working or retired.
Coined by the business guru Charles Handy in his book The Age of Unreason in 1989, having a portfolio life means you have multiple interests and can apply them in a variety of fields and contexts - some we do for money like starting a new business, some we do for interest like studying for a degree, some for pleasure like a hobby and some for a cause like becoming a charity trustee or volunteer. The key is we can juggle them all and have a more fulfilling life, especially in later life.
Whether we reach that 100-year milestone or not, the way we live our lives is changing rapidly – the key is to enjoy it and ensure we have the savings and investments to support us.
Whatever retirement means to you and whenever you plan to retire, planning ahead will help bring financial clarity to the lifestyle changes you want to make and the ambitions you have for your future. Our team of financial planners can review your current savings, model your likely expenditure and let you know if you are on track to enjoy the retirement you deserve.
1 Office for National Statistics – life expectancy in the UK: 2018-2020
2 Dept for Work & Pensions: The Gender Pensions Gap in Private Pensions, 5 June 2023
3 World Economic Forum, We’ll Live to 100 – How Can We Afford It?, May 2017
4 Office for National Statistics – What are your chances of living to 100?
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Important information
The contents of this publication do not constitute a personal recommendation or advice and the products and/or services referred to may not be suitable for all investors. It is important to consult a professional adviser before taking any action or making any decisions.
The value of investments and the income derived from them can go down as well as up and you could get back less than you originally invested. Your capital is at risk.
Tax treatment is dependent on individual circumstances. This information is provided in good faith and is based upon our understanding of current tax law and HMRC practice, which may be subject to change in the future.
Investec Wealth & Investment (UK) is a trading name of Investec Wealth & Investment Limited which is a subsidiary of Rathbones Group Plc. Investec Wealth & Investment Limited is authorised and regulated by the Financial Conduct Authority and is registered in England. Registered No. 2122340. Registered Office: 30 Gresham Street. London. EC2V 7QN.