Four steps to tax-efficient retirement income

Carefully structuring your income in retirement can make a big difference to how much tax you pay. This may be more important following the announcement in the 2024 Autumn Budget that pensions will be included in inheritance tax estates from April 2027. Planning ahead could mean more money to put towards enjoying your retirement or pass on to future generations.

 
Here, we look at four sources of retirement income and how they could be used together to help you pay less tax.

Four sources of retirement income

Income in retirement can come from several different sources, all of which are taxed in different ways. These include:

1. Pensions: you can usually withdraw up to 25% of your pension as a tax-free lump sum (capped at £268,275), with subsequent withdrawals taxed at your marginal rate of income tax.
2. Individual Savings Accounts (ISAs): you can withdraw as much money as you like from ISAs without paying tax.
3. Savings accounts: basic-rate taxpayers can earn up to £1,000 of tax-free interest on savings each year; this reduces to £500 for higher-rate taxpayers and £0 for additional-rate taxpayers.
4. General Investment Accounts: the capital gains tax (CGT) exemption lets you realise up to £3,000 of tax-free gains in the 2024/25 tax year.

Other sources of tax-efficient retirement income may include offshore bonds and venture capital trusts, but these are complex so make sure you seek advice on whether they’re suitable for you.

Planning income withdrawals

The example below demonstrates how one couple could draw income from their savings and investment pots to reduce how much tax they pay in retirement.

The couple, Robert and Olivia, have saved a total of £2m as follows:

 
Robert and Olivia have both already used their pension tax-free cash lump sum to pay off a mortgage, and now wish to withdraw a combined income of around £60,000 a year in retirement. At £30,000 each, this puts them in the basic-rate income tax band.

Robert and Olivia both qualify for the full income tax personal allowance, which enables each of them to withdraw £12,570 a year from their pensions tax free. Of this, £11,500 comes from the state pension and just over £1,000 from personal pensions. Robert and Olivia also withdraw £13,430 each from their ISAs and £1,000 from their savings accounts tax free. Finally, they each take £3,000 from their General Investment Accounts by realising capital gains within their CGT exemption.

 
In total, Robert and Olivia have managed to withdraw a joint income of £60,000 without paying any tax whatsoever on the money they’ve withdrawn. However, if they had each held £1m in pensions alone (on top of their state pensions), they would have to pay around £8,700 in tax between them to receive their net annual income of £60,000. Over a ten-year period, this could amount to around £87,000 paid in tax.

Personal pension contributions offer tax relief at your marginal rate of income tax (subject to limitations), while ISA contributions are paid in after tax but benefit from tax-free withdrawals. This is why using both pensions and ISAs to save for your retirement can be a really efficient way of building retirement income.

Seek advice

The above case study is just one example of how to draw tax-efficient income in retirement. The method that is right for you will depend on your individual circumstances, which is why it’s important to get some financial or tax advice. By understanding you and your goals, an adviser will be able to create a retirement income strategy that is not only tax efficient but is designed to help your money last as long as it needs to.

The value of investments, and any income from them, can fall and you may get back less than you invested. This does not constitute tax or legal advice. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Information is provided only as an example and is not a recommendation to pursue a particular strategy.