Slash your retirement tax bill by tens of thousands: Far too many are paying a hefty price for spending their pension pots unwisely. Try these four hacks that won’t cost you a single penny

Pensioners are being forced to hand over an ever greater chunk of their income to the taxman every year, which leaves them less to live on and enjoy.

Even those with very modest incomes on top of their state pension now face a bill.

But there are simple techniques that cost nothing and could slash your tax bill by hundreds or even thousands of pounds.

Even just changing the order in which you spend your assets, such as pensions, money in Individual Savings Accounts (Isas) and other savings accounts, can save you on tax.

David Little, partner at wealth manager Evelyn Partners, suggests thinking of your income in retirement like a jigsaw puzzle.

‘A household might have pensions, Isas, cash, investment accounts and tax-free pension cash available,’ he says. ‘The order and mixture of those jigsaw pieces and how they are used can make a surprisingly large difference.’

Taking action on tax is increasingly important. The number of pensioners paying the higher income tax rate of 40 per cent has doubled in the last five years alone to well over a million, figures from pensions consultancy LCP show.

Here are four ways you could cut your tax bill in retirement.

Use your tax-free allowance every year

A common error made by early retirees in particular is to spend savings in Individual Savings Accounts (Isas) first and pensions after that.

Spending in this order has been particularly popular as pensions can currently be passed on free of inheritance tax, so retirees often hold on to these last to pass on to loved ones and spend other assets instead.

But the rules change in April next year so that pensions lose this advantage and it will no longer be preferable to hold on to them for inheritance tax reasons.

Spending pensions alongside other savings can be hugely advantageous. Say you retire at 60 and need £25,000 a year to live on. At 67 you’ll receive the full state pension but you need to bridge the seven-year gap until it starts.

You may be tempted to take £25,000 a year from your Isas and leave your pension untouched.

For those seven years you will have no tax to pay because Isa withdrawals are tax free.

By the same token, that means you’re also not making use of your annual £12,570 tax-free personal allowance.

Say instead that you took £12,570 a year from your pension for those seven years. You would have no tax to pay because you are not exceeding your personal allowance. You would have withdrawn a total of £87,990 from your pension completely tax free.

If you withdrew that £87,990 after you have started to claim your state pension, almost every penny would be taxable. That’s because your state pension would use up virtually all of your personal allowance. If you pay the basic rate of 20 per cent, you’d have a potential tax bill of £17,598.

Evelyn Partners’ David says that retiring early and living entirely on cash and Isas until state pension age is one of the biggest mistakes he sees.

‘Instead, see these intervening years as a valuable tax planning window, making sure you use as much of your personal allowance as possible,’ he says.

Potential tax saving: £17,598

Move savings into your spouse’s name

Everyone has tax-free allowances, such as the personal allowance and the personal savings allowance. Breach these and you pay tax.

But couples who are married or in a civil partnership can move wealth between them to make maximum use of both of their allowances and slash their overall bill.

Say, for example, you receive the full state pension, have a £10,000-a-year workplace pension and savings that generate £10,000 of interest in your name. Your spouse, meanwhile, just receives the full state pension.

As the savings are in your name, all of the interest counts towards your income. The personal savings allowance gives basic rate taxpayers a £1,000 allowance, so the remaining £9,000 will incur tax. Savings interest is taxed at your income tax rate – in other words 20 per cent for a basic rate taxpayer, which would amount to a £1,800 bill.

If you moved your savings into your spouse’s name, they would pay far less tax on the interest.

If your spouse receives the full new state pension of £12,547.60, that means they have £22.40 of their £12,570 personal allowance remaining. Because they have a low income, they also benefit from the Starting Rate for Savings, which taxes up to £5,000 of savings interest at 0 per cent. Savers get the full £5,000 if their other income is no more than your £12,570 personal allowance; above that it reduces by £1 for every £1 of extra income.

Your spouse also gets the £1,000 personal savings allowance. These combined mean they can receive £6,022.40 of interest tax free.

That means just £3,977.60 of the £10,000 interest is taxable. If you keep this sum in your name so you can also take advantage of your own £1,000 personal savings allowance that leaves just £2,977.60 to incur a tax bill.

This would be taxed at 20 per cent, resulting in a bill of £595.52 instead of £1,800 if the full savings had been kept in your name.

That saves £1,204.48 a year, or £12,044.80 over ten years if rates, allowances and interest stay the same.

Potential tax saving: £1,204.48 a year

Spread out your 25 per cent pension tax-free lump sum

It can be tempting to take your 25 per cent pension tax-free lump sum all in one go. However, if you do this, all subsequent withdrawals are taxable and you may end up paying more to HMRC overall.

The key is to use your tax-free withdrawals to keep your taxable income below the higher or additional rate tax bands if you can.

Say, for example, you and your partner need £50,000 a year to live on and both receive the full state pension of £12,547.60. That means you need to find £24,904.80 after tax to meet your £50,000 target.

If you’ve already taken your full tax-free lump sum in a previous year, the £24,904.80 you withdraw from your pension will be taxable – so you’ll need to withdraw £31,125.20 to get there.

Your state pensions will use virtually all of your personal allowances, so you’ll only have a combined £44.80 in allowances left.

The remainder is taxed at 20 per cent, resulting in a total bill of £6,220.

Now let’s say you hadn’t yet used up your tax-free allowance and had Isas you could make tax-free withdrawals from as well.

For example, to make up the £50,000 you used your state pensions, you take £20,000 from your pensions – including £5,000 tax free. As before, you would have £44.80 of your personal allowance remaining after your state pension has used up the majority. But this time, only £15,000 of your pension withdrawal is taxable, which produces a bill of around £2,991. That would mean you’d only have to withdraw £17,009 from your pension. If you then topped that up with a £7,896 withdrawal from Isas, you would have to pay around £3,225 less tax that year.

Some of this saving may only be deferred, as money left in your pension could be taxed when you eventually withdraw it. However, if you cut your taxable income so that it sits just below the higher or additional rate threshold, you will make a substantial saving.

Adrian Murphy, chief executive at wealth manager Murphy Wealth, says: ‘More people need to think about spreading withdrawals from pensions, especially if they are otherwise tipping into higher-rate tax.’

Potential tax saving: Around £3,225 in that year

Pay into a pension even if you’re retired

You can still get tax relief on pension contributions after you retire, even if you no longer have any earnings.

Say you and your spouse are both 70, retired and receive the full state pension. You also have workplace pensions but neither of you has any earnings.

It’s a common mistake to assume there is no point paying into a pension once you have retired.

But even with no earnings, you can each pay £2,880 a year into a pension until 75 and have it topped up to £3,600 by HMRC.

And if you do have some earnings in retirement – perhaps £5,000 a year from consultancy or part-time work – you may be able to contribute more and get tax relief on it.

If neither of you has any earnings, you can each pay £2,880 into a pension and HMRC will add £720 to each contribution. That puts £7,200 into your pensions for a total cost to you of £5,760.

If one of you also earns £5,000 from consultancy, you could instead make a £5,000 gross pension contribution based on those earnings, paying £4,000 yourself with HMRC adding £1,000.

There is a catch, however. Pension withdrawals can later be taxable, so some of the benefit may be clawed back when you take the money out.

Secondly, you may be restricted to putting up to £10,000 a year into your pension if you have already drawn money from it. This rule is known as the Money Purchase Annual Allowance and applies if you’ve accessed a defined contribution pension.

Potential tax relief: £1,440 in one year – and more if you’re still earning

moneymail@dailymail.co.uk