How We Calculate UK Tax Year-by-Year
Most retirement modelling tools treat tax as an afterthought. A flat percentage, or a rough estimate applied at the end.
That’s a problem, because for most people approaching retirement in the UK, tax is the single biggest variable they can actually influence. The order you draw from your accounts, the year you crystallise your pension, whether you take income above £100,000 — these decisions can shift your lifetime tax bill by tens of thousands of pounds. A model that gets tax wrong will give you a materially different picture of your retirement, and you won’t know it’s wrong unless you check.
When I built FutureClear’s simulation engine, tax went in first, not last.
What “year-by-year” actually means
Every time you run a projection in FutureClear, the engine simulates your entire financial timeline — from today through to your life expectancy. It doesn’t use a single formula. It runs a loop that processes each year individually, then carries the results forward into the next year.
Each year, the engine runs through a pipeline of 18 steps. It collects your income, processes life events (retiring, downsizing, starting a pension), executes spending, generates withdrawals from your accounts, and then calculates the tax bill that results from all of that activity.
The tax from year 14 feeds into year 15. The Personal Allowance taper in year 8 affects how much cash you have in year 9. The capital gain from selling your buy-to-let in year 6 interacts with your dividend income and pension drawdown in that same year to determine which tax bands apply.
A single formula can’t capture this. Tax in retirement is path-dependent — every year depends on what happened in the years before it.
Inside the tax calculation
What the engine computes for each person, for each year of the simulation:
1. Income tax
The engine aggregates all taxable income for the year:
- State pension
- Employment income (if you’re still working)
- Pension drawdown (the taxable portion — the 75% after your tax-free lump sum)
- Defined benefit pensions
- Annuity income
- Buy-to-let rental income
- Room rental income (above the £7,500 Rent-a-Room allowance)
- Miscellaneous income
It then calculates the Personal Allowance — including the taper. If your adjusted net income exceeds £100,000, your Personal Allowance reduces by £1 for every £2 above that threshold, until it reaches zero at £125,140. This is the “60% tax trap” (you’re effectively paying 40% income tax plus losing 20% of your allowance simultaneously). The engine models this precisely.
From there, it applies the standard bands:
| Band | Threshold | Rate |
|---|---|---|
| Personal allowance | £12,570 | 0% |
| Basic rate | £12,571 – £50,270 | 20% |
| Higher rate | £50,271 – £125,140 | 40% |
| Additional rate | £125,141+ | 45% |
These thresholds are frozen until April 2031. The engine uses the actual HMRC figures — £12,570, £50,270, £125,140 — not rounded approximations.
2. National Insurance
For years where you have employment income, the engine calculates Class 1 employee NI contributions:
- 8% on earnings between £12,570 and £50,270
- 2% on earnings above £50,270
NI stops when you reach State Pension age. The engine knows this and stops calculating it at the right year.
3. Dividend tax
If you hold investments in a GIA (General Investment Account), the engine calculates dividend income based on your opening balance and the dividend yield assumption.
Dividends have their own tax treatment. The first £500 per year is tax-free (the dividend allowance). After that:
| Band | Rate |
|---|---|
| Basic rate | 10.75% |
| Higher rate | 35.75% |
| Additional rate | 39.35% |
Dividends sit on top of your other income in the tax bands. If your salary and pension drawdown already push you into the higher rate band, your dividends are taxed at the higher rate from the first pound above the allowance. The engine handles this stacking correctly.
It also includes dividends in the adjusted net income calculation for the Personal Allowance taper — a detail that many calculators miss, and one that HMRC specifically requires.
4. Capital gains tax
When the engine sells assets from your GIA — to fund spending, or through a Bed-and-ISA transfer — it calculates the capital gain using a cost basis ratio. The annual CGT allowance (£3,000) is applied first, then the remaining gain is taxed at:
| Band | Rate |
|---|---|
| Basic rate taxpayer | 18% |
| Higher/additional rate | 24% |
Whether you’re a basic or higher rate taxpayer for CGT purposes depends on your total income including dividends — another interaction the engine tracks.
5. Marriage Allowance
For married couples where one partner has unused Personal Allowance and the other is a basic rate taxpayer, the engine automatically transfers up to £1,260 of Personal Allowance. This produces a tax credit of £252 (£1,260 × 20%) for the recipient.
The engine evaluates eligibility each year because it can change — one partner might move above the basic rate threshold in some years but not others.
6. Section 24 mortgage interest relief
If you have a buy-to-let with a mortgage, the engine applies the Section 24 tax credit: 20% of the mortgage interest, offsetting your tax bill. This replaced the old system of deducting mortgage interest from rental income — a change that hit higher-rate taxpayer landlords particularly hard.
Why this level of detail matters
Consider a real example. Say you’re 57, retired, with £400,000 in a SIPP and £150,000 in an ISA. You want to spend £35,000 a year.
A simple calculator might say: draw £35,000 from your SIPP, pay some tax, done.
But the year-by-year engine shows you what actually happens:
- In years before your state pension starts at 67, you have your full Personal Allowance available for pension drawdown. You can draw £12,570 completely tax-free from your SIPP.
- Once state pension kicks in (£12,548 for the full new state pension), that almost entirely consumes your Personal Allowance. Now nearly all your pension drawdown is taxed.
- If you draw too much in any single year, you might trigger the Personal Allowance taper — creating an effective marginal rate of 60%.
- Drawing from your ISA in the early years preserves your SIPP for later, but means your tax-free ISA wrapper is shrinking during a period when it could be growing tax-free.
These interactions compound over 30+ years. A model that misses any of them will give you a different — and wrong — picture of your retirement.
Tax is calculated, then paid the next year
One detail that matters more than you’d think: the engine calculates your tax bill at the end of each year, but deducts it from your cash at the start of the next year. This mirrors how self-assessment actually works — your 2026/27 tax bill is due in January 2028.
This matters because your cash position at the end of a year includes money you’ll owe HMRC. The engine tracks this accrual so you see the true picture, not an artificially inflated one.
What we don’t do
This is a modelling tool, not a tax return. There are things we deliberately simplify:
- Cost basis tracking: We use a static cost basis ratio for GIA assets rather than tracking the actual cost basis of every contribution. This is a reasonable approximation for long-term planning but won’t match your exact CGT liability in any given year.
- NI for the self-employed: We currently model Class 1 employee NI. Self-employed NI (Class 2 and 4) is on the roadmap.
- Salary sacrifice: Not yet modelled as a distinct mechanism. You can approximate it by adjusting your pension contribution amounts.
I’d rather be upfront about these simplifications than pretend they don’t exist. Every model makes trade-offs; what matters is that you know where they are. Where possible, we use published data sources — HMRC tax rates and thresholds, ONS mortality data, and return distributions consistent with those used in financial planning — so you can verify the assumptions yourself.
You can verify this yourself
Every tax constant in the engine references the current HMRC figures. The Personal Allowance is £12,570. The basic rate band extends to £50,270. The CGT allowance is £3,000. The dividend allowance is £500. These aren’t estimated — they’re the published numbers, updated when the tax year changes.
For a deeper dive into how UK income tax works in retirement, see our Learn article on Income Tax.
FutureClear is a modelling tool, not a tax adviser. Tax calculations are based on published HMRC rates and thresholds for the 2026/27 tax year. Your actual tax position depends on your individual circumstances. If in doubt, consult a qualified tax professional.