Halloween is just weeks away on 31 October. For those approaching retirement, the genuinely frightening things are not monsters under the bed or zombies at the window – they are scary tax traps that could disrupt your plans for this exciting new life chapter.
Seemingly minor financial decisions made just before or during retirement could trigger unnecessary Income Tax, increase your estate’s Inheritance Tax (IHT) liability, or reduce your ability to grow your pension pot tax-efficiently.
Fortunately, with the right support, advice, and planning, you could avoid these frightful mistakes and protect your retirement funds from avoidable tax.
Read on to discover four common tax traps that catch people out in the run-up to retirement and learn how timely financial advice could help you keep tax nightmares at bay.
1. Exceeding available tax-free allowances for pension withdrawals
You can usually access workplace and private pensions from age 55 (rising to 57 from 6 April 2028). This could provide a valuable source of income before or after you retire.
However, it’s crucial to understand the tax implications of drawing on your pension.
While the first 25% of your pension pot is typically tax-free up to a limit of £268,275 (the Lump Sum Allowance, or LSA), the taxable portion of your pension is normally subject to Income Tax at your marginal rate. It’s important to note that the 25% threshold applies to your total pension savings, not each individual scheme. Therefore, if you take a lump sum from several pensions without checking how much of your allowance remains, you could be in for a fright when your next tax bill arrives.
You or your beneficiaries may be eligible to take a tax-free lump sum of up to £1,073,100 in certain circumstances, for example, if funds are paid out due to serious illness. This is known as the Lump Sum and Death Benefit Allowance (LSDBA). If you withdraw more than this, you’ll need to pay Income Tax on the amount that exceeds the allowance.
Your LSA and LSDBA may be higher if you hold a protected allowance. It’s worth using the government’s free online tool to check your allowances before planning your pension withdrawals.
2. Triggering the Money Purchase Annual Allowance
The standard pension Annual Allowance for the 2026/27 tax year is £60,000, which is the maximum that can be contributed to all private and workplace pensions before a tax charge applies. However, if you start making flexible withdrawals of taxable money from a defined contribution (DC) pension, this triggers the Money Purchase Annual Allowance (MPAA).
The MPAA caps the amount you and your employer can contribute to DC pensions in a single tax year without incurring an Annual Allowance tax charge at £10,000. Moreover, once the MPAA has been triggered, it remains in place for life.
As such, if you want to continue topping up your pension after accessing it – for example, because you plan to keep working or running a business – it’s important to factor this into your financial plan.
3. Losing the Personal Allowance: the 60% tax trap
For 2026/27, most people have a Personal Allowance of £12,570. This is the amount of income you do not have to pay tax on.
However, your Personal Allowance is reduced by £1 for every £2 that your “adjusted net income” (total taxable income before any Personal Allowances and less certain tax reliefs) exceeds £100,000 in a single tax year. You lose your Personal Allowance altogether if you earn £125,140 or above.
As income between £100,000 and £125,140 falls into the higher-rate Income Tax bracket (40%), for every £100 you earn within this range, you’ll pay £40 Income Tax and lose another £20 due to the tapered Personal Allowance. This creates an effective marginal rate of 60% (or 67.5% in Scotland).
Taxable pension withdrawals count towards adjusted net income. So, if you take a large lump sum from your pension, this could push your total income over £100,000, triggering the 60% rate.
Instead, consider spreading taxable withdrawals across tax years, using available allowances and reliefs, and coordinating your pension income with other sources of income.
4. Failing to prepare for upcoming changes to Inheritance Tax on pensions
Currently, unused pension funds are usually exempt from IHT, making them an effective way to pass wealth on tax-efficiently.
However, from 6 April 2027, most unused pensions and death benefits will be included in the value of your estate for IHT purposes.
This is a major reform which could have a significant impact on your retirement and estate plans.
Indeed, failing to review and update your plans in line with the new rules could leave your family facing an unexpected – or higher-than-expected – IHT bill, reducing the amount of wealth they receive.
There could be further changes to tax legislation announced in John Healey’s first Budget on 28 October. Keep an eye out for our update on the day to find out whether there are any reforms that could affect your long-term financial plan.
We can help you keep your retirement wealth as tax-efficient as possible
Retirement should be a time to enjoy the wealth you’ve worked hard to build over the years, not to be haunted by avoidable tax bills.
However, navigating tax rules and effectively coordinating different sources of income can be frighteningly complex.
We can help you identify potential tax traps and take steps to avoid them before they become a problem.
Our financial planners can use sophisticated software to model different income strategies, allowing you to make informed decisions and keep more of your wealth working for you.
To find out more about how we can help you plan financially for retirement, please email hello@bluewealth.co.uk or call us on 0117-332 0230.
Please note
The content of this newsletter is offered only for general informational and educational purposes. It is not offered as, and does not constitute, financial advice.
Blue Wealth is not responsible for the accuracy of the information contained within linked sites.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning, cashflow planning, or tax planning.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
Workplace pensions are regulated by The Pensions Regulator.
