6 Your pension income: before and after tax
By now you should understand the options you have when it comes to your pension, and what is involved in forecasting the income you will receive. Now you can use this information to get a good estimate of the pension income you will have at your disposal to meet your spending needs in retirement.
Once you have a summary of your pension pots and forecasted income, add this to your state pension income, plus any other regular income you have. This could include state benefits, rental income from properties that you let or earnings from other savings and investments.
As you saw earlier, if you have defined contribution pensions you can estimate the pension income you could get using this calculator:. Open the link in a new tab or window so that you can easily return to the course.
You should now have your estimated gross income in retirement. You now need to take into account how much tax will be deducted from your gross income.
What about tax?
While up to 25% of your pension pot can be taken tax-free, the other 75% counts as taxable income if it is taken as a lump sum payment. Any annual income you take – for example from an annuity – will also count as taxable income.
Income tax will apply when your total income, including any taxable lump sums, state pension and other taxable non-pension income, exceeds the annual personal allowance (£12,500 in 2020/21). Make sure you are aware of the tax implications of your withdrawals in advance so you don’t end up with an unexpected additional bill.
Find out how much income tax you’d currently pay on your retirement income. The following sources can be used to calculate this (if you use any of the online calculators open them in a new tab or window so that you can easily return to the course):
- The gov.uk calculator
- The Scotfact calculator if you live in Scotland
- The calculator provided by the consumer magazine Which?
- The tax calculation guidance provided in the following document: Income Tax 2020/2021
Before you start, make sure you have your gross income details ready, as well as your current income tax code (e.g. 1250L if you live in England or Northern Ireland, C1250L if you live in Wales or S1250L if you live in Scotland). Do not include any tax-free lump sums in your calculations.
Ignore any National Insurance Contributions (NICs) shown in the calculators since you don’t pay these on pensions or if you are older than state pension age (SPA). One way to ensure these are not calculated is to say you are over state pension age even if you are not.
You may note some very small differences in the answers provided caused, for example, by the rounding of numbers in the calculation process.
Is my post-tax pension income enough for me?
Having done your calculations, you can deduct the income tax you will pay from your gross income, and then you will know your disposable (or ‘net’) pension income. Remember, though, that you’ll need to revise these tax calculations each year as income tax thresholds and rates do get changed.
Now compare this disposable income with your forecast of spending (you completed this earlier in the course) and you can see whether you have enough to get you the type of retirement you want.
If you’re fortunate to generate enough income to cover your spending in retirement, then you’re on track. If there’s a shortfall, there are ways you can address this.
You’ll explore these options next.