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08 May 2024

6 ways pensioners can cut their tax bill in 2024-25

From using the marriage allowance to taking your 25% tax-free pension lump sum gradually

Grace WitherdenSenior writer

It's estimated 1.6 million more pensioners could be pushed into paying income tax within four years, thanks to a phenomenon known as ‘fiscal drag’.*

This can occur when tax rates and thresholds are frozen but people still end up paying more tax through, for example, their income rising.

So with the personal allowance (the amount you can earn before paying any income tax) frozen at £12,570 until 2028 and the state pension rising by a bumper amount this year, pensioners could be hit with a tax bill.

Here, Which? explains if and when pensioners need to pay tax on their state pension, and six ways to pay less tax in 2024-25.

How is the state pension taxed?

The state pension isn't tax-free, but the money you receive is paid 'gross' – without any tax being deducted.

If your total income from all sources, including the state pension, is greater than your personal allowance, tax is due on your state pension. This will normally be deducted from any private pension or earnings you might have, which are paid through the PAYE system.

However, if you have no PAYE income, you'll have to complete a self-assessment tax return and pay any tax due directly to HMRC.

Currently, the full rate of the new state pension is worth £11,502 a year and the personal allowance is set at £12,570 for most people. So if you have a workplace pension, or any other form of income, it’s very likely this will push you over your personal allowance and into paying basic-rate tax.

Find out more: how much is the state pension worth in 2024-25?

Need help with your tax return?

Send your tax return to HMRC using the service provided by GoSimpleTax.

Calculate your tax bill

Six ways pensioners can pay less tax

There are some ways you can reduce the amount of tax you pay as a pensioner.

1. Access tax-free pension cash gradually

You can usually take up to 25% of the amount built up in any pension as a tax-free lump sum. The most you can take is £268,275.

However, many pensioners don’t need to take it all in one go. What you don’t take out can be left invested in your pension where it can grow tax free – and then give you chunks of tax-free cash when you need it.

Henrietta Grimston, director of financial planning at wealth manager Evelyn Partners said: ‘The 25% tax-free portion of a pension pot is the headline-grabber, and some savers opt to take this as a one-off lump sum. But it can also be accessed incrementally, with 25% of each withdrawal taken tax free, and this strategy can be useful in minimising the overall tax burden.

‘For instance, someone determined to pay no tax at all on their pension income in 2024-25 could set their annual withdrawal at £1,424 gross. Of this, 75% (£1,068) falls within the personal income tax allowance, while the remaining 25% (£356) is taken from the tax-free element of the pot.'

Find out more: should I take a lump sum from my pension?

2. Up your pension contributions

Many pensioners don’t realise they can continue paying into their pension, even if they’ve given up work or accessed their retirement savings already.

If you’re a UK resident and under 75 you can still save and earn tax relief on your pension contributions.

However, if you’ve already taken money from a money purchase, or defined contribution pension, your contributions (including tax relief) will be capped at £10,000 a year. This is known as the Money Purchase Annual Allowance (MPAA).

Continuing to pay contributions into your pension also could move you into a lower tax bracket as it helps reduce your overall income.

Find out more: how the pensions annual allowance works

3. Maximise tax-free savings allowances

Those on low incomes can access a special ‘starter rate’ for savings, which allows them to earn interest up to £5,000 without paying tax. Every £1 of other income (for example your pension) above your personal allowance reduces your starting rate for savings by £1.

You may also be able to earn up to £1,000 in interest before paying tax on your savings if you’re a basic-rate taxpayer, and up to £500 if you’re a higher-rate taxpayer under your personal savings allowance. Additional-rate taxpayers have no personal savings allowance.

It helps to think of these allowances sitting on top of each other; first the personal allowance (£12,570), then the £5,000 starting savings rate, and finally the personal savings allowance worth up to £1,000. This effectively means that you can earn up to £18,570 in 2024-25 before having to pay any tax on savings interest.

Find out more: tax on savings interest explained

4. Open an Isa

For those with larger savings pots, or additional-rate taxpayers, an Isa is a great way to save paying tax on savings interest or investment income.

You can put up to £20,000 in a cash and/or stocks and shares Isa and any income generated can grow completely tax-free, protecting your savings now and in the future.

Isa rules have changed this year and savers are now able to open and pay into multiple Isas of the same type, annually. You can also withdraw money from Isas anytime tax-free if you want to supplement your other income without paying any tax.

Find out more: best cash ISA rates 2024

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5. Consider NS&I premium bonds

Premium bonds are a savings product from National Savings & Investments (NS&I) that offer the chance of winning between £25 and £1m each month.

The prizes are paid tax-free and do not count towards your personal savings allowance.

However, there is a chance you could win nothing at all – and, as your savings won't be earning any interest, they will effectively lose value over time due to inflation.

Find out more: should you get premium bonds?

6. Share your allowances

If you're in a relationship, investment firm AJ Bell says organising finances between you can make allowances go even further and save you more on tax.

For example, if your partner has an unused personal savings allowance then cash could be held in their name instead. Or, if one you is a lower-rate taxpayer, it might make sense for them to have the bulk of the non-ISA savings so you pay a lower tax rate on the savings interest.

You can also use marriage allowance which saves couples money by allowing the lower or non-earner to reduce the amount of tax their partner pays by transferring up to £1,260 (or 10%) of their personal allowance to their spouse or civil partner.

The higher-earning spouse, who must be a basic-rate taxpayer, will then receive a tax credit equivalent to the amount of personal allowance that has been transferred to them. This is deducted from the amount of tax they would usually have to pay.

You can reduce your annual tax bill by up to £252 by claiming marriage allowance and you can backdate your claim for up to four tax years.

Scottish income tax has different bands and rates; you can claim marriage allowance if the higher-earning partner's salary falls between the Scottish starter, basic rate or intermediate rate of tax – essentially the higher-earning partner's salary would have to be less than £43,662.