Retirees are paying frightening amounts of tax. Don’t join them

From April, the dividend tax allowance is a miserly £500. Tax-sheltered investment accounts have never been a smarter move.

| More on:
Older couple walking in park

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The other day, my annual tax code notice arrived.

And my personal allowance — which, as with most people, is £12,570 — is now very largely swallowed up by the state pension. (Yes — I’m that old…)

So in the coming tax year, if my total earnings and unsheltered investment income exceed a sum just over £2,000 — and they will — then I’ll be paying income tax on them.

Frozen figures create a bigger tax take

It’s no mystery what’s happening here.

The personal allowance hasn’t changed since the 2021-2022 tax year, and neither has the higher rate threshold — the point at which individuals pay tax at 40%, instead of 20%.

Nor will either of them change until 2028, successive chancellors have said.

So consequently, many more people are being caught in the tax net with each passing year, until allowances and income thresholds — hopefully — rise again.

People who didn’t pay tax at all are now paying tax. People who paid basic rate tax are now paying higher rate tax, because their pay rises have taken their earnings above the higher rate threshold of £50,270.

Economists call it ‘fiscal drag’.

Fiscal drag in action

The other day, the Office for National Statistics published some figures — well, quite a lot of figures, really — in a lengthy and detailed annual publication called Personal Incomes Statistics 2021-2022.

The date is significant: that’s right at the very start of the post-pandemic seven-year freeze in allowances and tax thresholds.

But the data already amply illustrates successive chancellors’ miserly approach raising them in the past.

There were 800,000 thousand more basic rate taxpayers than the year before. 400,000 higher-rate taxpayers. And around 70,000 more additional rate taxpayers.

And over the next few years, experts expect that those numbers are going to increase quite significantly.

Squeeze the old

Most troubling is what’s happening with older taxpayers — those individuals above state pension age.

Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, sums up the situation well:

“Pensioners continue to make a huge contribution to the nation’s tax bill. They now account for over 20% of all taxpayers and almost 15% of total income. One in ten taxpayers is over the age of 75 — this is up from 7% in 2011/12 in a reflection of our ageing society.”

There were 6.74 million taxpayers of state pension age. 409,000 were self-employed, and 1.2 million received employment income. Sure, some people might want to carry on working after the state pension age — me, for instance — but, like you, I know of plenty of people who have jobs on the side because they actually need the money.

And quite a lot — the majority, in fact — are in receipt of non-state pension income, from either past employment or private pensions.

Taxation in retirement

What are the implications of all this for your retirement investment planning?

For those investing through SIPPs, then your pension income is taxable, full stop. And if your state pension and your SIPP income together exceed the personal allowance, you’ll pay tax.

ISA income? Under present tax rules, ISA income is free of tax. This is very handy when you’re building your retirement ISA pot (as is the fact that ISAs are also free from capital gains tax), but is absolutely crucial in retirement.

Because otherwise, you’ll pay dividend tax — a tax that didn’t used to exist, and in my view represents a double tax-grab on corporate earnings. In fact, says Hargreaves Lansdown, this year dividend tax is expected to rake in £17.4 billion for the chancellor.

For basic rate taxpayers, dividend tax (after the £1,000 allowance) is currently 8.75%. For higher-rate taxpayers, it’s a whopping 33.75%. Ouch.

Run for shelter

The bottom line?

In my view, things are only going to get worse.

This coming tax year, the dividend allowance shrinks to just £500 — a mere one-tenth of the £5,000 it stood at when introduced in the 2016-2017 tax year. Any investment income above £500, then you’re liable for income tax.

Yet large numbers of us continue to hold investments in brokerage and investment accounts — with fund supermarkets, for instance — that aren’t tax-sheltered.

Granted, it’s difficult, as you can — under present ISA rules — only shelter £20,000 a year. Limits also apply to SIPP contributions, at least in terms of the allowed tax rebates.

We’re almost at the end of the current tax year. From April 6th, we’re in a new tax year. Over the next month or so, you could shelter £40,000, if you have it sitting in unsheltered accounts. As many of us do.

Do it today. Your retired self will thank you for it.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

The Motley Fool UK has recommended Hargreaves Lansdown Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

happy senior couple using a laptop in their living room to look at their financial budgets
Investing Articles

Investing freedom — but inside a pension

Strapped consumers might be cutting back on investing, but they’re still keeping up their pension contributions. The only problem? A…

Read more »

Mature Caucasian woman sat at a table with coffee and laptop while making notes on paper
Investing Articles

Forget gold! I’d rather buy these 3 FTSE high-yielders in a Stocks and Shares ISA

Gold looks like a risky investment to me as the price hits an all-time high. I'm ignoring the fuss to…

Read more »

Young female business analyst looking at a graph chart while working from home
Growth Shares

This 55p UK stock could rise more than 300%, according to a City broker

This UK stock has fallen from above 800p to below 60p. But analysts at Citi believe it’s capable of a…

Read more »

Businesswoman analyses profitability of working company with digital virtual screen
Investing Articles

I think this FTSE 250 trust has all the right ingredients to lock in long-term profits

Today I'm examining the prospects of a private equity investment trust on the FTSE 250 that caught my attention recently…

Read more »

Young black man looking at phone while on the London Overground
Investing Articles

2 under-the-radar UK shares investors should consider snapping up

Two UK shares have caught the eye of our writer. She explains why investors should be taking a closer look…

Read more »

Investing Articles

Are these 2 ultra-high-yielding income stocks a good buy for me?

These two income stocks often split the debate amongst investors. So what does our writer think of them as potential…

Read more »

Senior woman potting plant in garden at home
Investing Articles

5% yield! This dividend stock could be great for my retirement

Our writer explains why this dividend stock appeals to her as she’s investing to build wealth to enjoy in the…

Read more »

A young Asian woman holding up her index finger
Investing Articles

I’d aim for a second income of £1,000 a month with this super-reliable dividend stock

I think a great way to build a second income stream is by investing in dividend stocks via a Stocks…

Read more »