Approaching retirement? Tips to drawing your income in the most tax-efficient way

Approaching retirement? Tips to drawing your income in the most tax-efficient way 

As you approach retirement or you’re already enjoying your golden years, this article explores the main sources for drawing a retirement income and what to consider for each option.

1. State Pension

Starting with the obvious, the foundational income source for many of you will be your State Pension, which is based on your National Insurance contributions. As of the 2024/25 tax year, the full new State Pension is £203.85 per week. Currently, the State Pension age is 66, but it is gradually increasing so make sure you stay updated on these changes.

2. Workplace Pensions

Most of you will be contributing to a workplace pension. There are two types:

1. Defined Benefit (DB) Pensions, or final salary pensions, which provide a guaranteed income based on your salary and years of service with your employer.
2. Defined Contribution (DC) Pensions. This is where the amount you receive depends on the contributions made by you and your employer, and the performance of your investments.

3. Annuities

You can use your pension pot to buy an annuity, which provides a guaranteed income for life or a specified period. There are various types, including:

• Level annuities which provide fixed payments
• Escalating annuities, where payments increase over time
• Joint annuities, where payments continue to a spouse after your death

4. Income Drawdown

There are a couple of options here.

• Flexi-Access Drawdown allows you to keep your pension invested while taking a flexible income. You can adjust the amount you withdraw based on your needs and the performance of your investments.
• Uncrystallised Funds Pension Lump Sum (UFPLS) is where you take lump sums directly from your pension pot, with 25% of each lump sum tax-free and the rest taxed as income.

`Income drawdown' will reduce the size of your pension fund and the investment growth may not be sufficient to maintain the level of income you wish to draw. If you withdraw money at a rate greater than the growth achieved by your investments, your remaining fund will reduce in value. The level of income you take will need to be reviewed if the fund becomes too small - this is more likely the higher the level of income you take. The income you receive may be lower than the amount you could receive from an annuity, depending on the performance of your investments. As annuity rates can change substantially and rapidly, there is no guarantee that when you do purchase an annuity the rates will be favourable. This could mean that your pension thereafter may be less than you hoped for. The rules governing how much income you can take directly from your pension fund may change. This could mean that the income you can take from the investment no longer meets your requirements.

5. Investment Income

Investments can be a robust source of income during retirement:

• Shares and Bonds: Generate varied income through dividends and interest payments.
• Property Rentals: Provide can a steady income stream. (Assuming reliable tenency)
• ISAs: Investments in Individual Savings Accounts grow tax-free, and withdrawals are also tax-free, making them an efficient way to generate income.

6. Savings and Cash Deposits

Interest earned on savings accounts can supplement retirement income, can be low so shop around.

Tips to Save on Tax

Once you’ve worked out the income you can draw once you retire, it’s essential you manage any tax liabilities effectively. Here are some things to consider:

• Utilise Tax-Free Allowances: As of the 2024/25 tax year, you can earn up to £12,570 annually tax-free. Additionally, up to 25% of your pension pot can often be taken as a tax-free lump sum.
• Diversify Income Sources: Spreading your income sources can reduce risk and increase financial stability.
• Plan Withdrawals Strategically: By planning your withdrawals, you can minimise tax liabilities and ensure the long-term sustainability of your income.
• Regular Reviews: Regularly review your financial situation and adjust your plans as necessary, considering market changes, inflation, and personal circumstances.

How we can help.

Generating income in retirement in the UK involves a mix of state benefits, personal and workplace pensions, investments, savings, and potentially part-time work.

So, my advice would be to make sure you plan ahead and diversify your income sources. At HJP, we can help ensure your retirement income strategy aligns with your needs and goals. We can also help ensure you review all your options and mitigate tax where possible.

Michael Phillips

Senior Chartered Financial Planner

HJP Chartered Financial Planners

The value of a pension will be directly linked to the performance of the funds you select and the value can therefore go down as well as up.  You may get back less than you invested. Equities do not provide the security of capital associated with a deposit with a bank or building society.

The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief is generally dependent on individual circumstances.

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