How to Draw an Income in Retirement Tax Efficiently: A Guide to Pension Income Planning

We’re living longer, and that’s great news. Retirement can be one of the most rewarding chapters of your life. However, living longer also means your retirement savings may need to provide an income for longer.

The way we retire has changed, too. For many people, retirement is no longer a fixed date when employment suddenly stops. You might choose to work part-time, gradually reduce your hours, change career or continue working in some form while accessing your pension.

At the same time, there are now more flexible options for taking an income from your pension.

When your salary or other employment income reduces or stops, everyday life doesn’t. Household bills, holidays, family commitments and personal goals continue. Creating a sustainable and tax-efficient retirement income strategy can therefore give you greater confidence about the years ahead.

So, how can you draw an income in retirement in a tax-efficient way?

Here are some of the key considerations.

Step 1: Think about what your ideal retirement looks like

Retirement isn’t simply stopping working and slowing down. It can be an opportunity to redefine how you want to spend your time and money.

Start by thinking about the lifestyle you want to enjoy. Perhaps you want to travel more, spend time with family, take up new hobbies or simply have greater freedom over your time.

Your plans will help determine how much income you may need and when you will need it.

It can be useful to separate your expected spending into three categories:

• Essential expenditure, such as household bills, food and utilities
• Lifestyle spending, such as holidays, hobbies and eating out
• Future or unexpected costs, such as home improvements, care costs or helping loved ones

Step 2: Work out how long your money is likely to last

One of the biggest questions people ask when approaching retirement is: “Will I have enough money to last for the rest of my life?”

There is no single answer. Your retirement income needs to take account of factors such as your pension savings, other investments and assets, State Pension, spending requirements, inflation, investment performance and how long you may live. We use a cash flow planning tool with our clients to work out whether they might need to adjust their current financial plans to achieve their goals.

The earlier you start thinking about your retirement plans, the more time you have to understand your options and make adjustments where appropriate.

Step 3: Understand your options for drawing an income

There are several ways to generate an income in retirement. The right approach will depend on your circumstances, life goals, attitude to investment risk and how much flexibility or certainty you want. Here are some examples:

• Pension drawdown

Flexi-access drawdown allows you to keep your pension invested while taking an income from it. You can generally choose how much to withdraw and when, giving you flexibility to adapt your income as your circumstances change.

However, because your pension remains invested, its value can rise and fall. Taking too much too quickly can also increase the risk of your pension running out sooner than expected.

• Annuities

You can use some or all of your pension to purchase an annuity, which can provide a guaranteed income for life or for a specified period, depending on the type selected.

Annuities can provide valuable certainty, although the income offered will depend on factors including the type of annuity, your age and circumstances and prevailing annuity rates.

Step 4: Plan a tax-efficient retirement income strategy

The most appropriate approach will depend on your income, pension arrangements, other assets, tax position and personal circumstances.

Some key considerations include:

• Make use of available tax allowances

The standard Personal Allowance is currently £12,570, although the amount available can be affected by your individual circumstances. You can also usually take up to 25% of your pension as tax-free cash, subject to the relevant allowances and limits.

• Consider your different sources of income

Your retirement income may come from a combination of your State Pension, workplace or personal pensions, investments, savings, property and, for some people, continued employment.

Looking at your finances as a whole can help you decide which sources of income to use and when.

• Plan withdrawals strategically

The amount and timing of your pension withdrawals can affect the amount of Income Tax you pay. Taking a large withdrawal in a single tax year, for example, could result in more of your income being taxed at a higher rate.

Careful planning can therefore help manage your tax position while supporting a sustainable income.

• Review your investments and income regularly

If you use pension drawdown, your pension remains invested while you take an income. This means your investment strategy needs to reflect both your income requirements and your approach to investment risk.

Regular reviews can help you consider changes in your circumstances, investment performance, inflation and tax rules, and whether your income remains sustainable.

Step 5: Think about the legacy you want to leave

Retirement planning isn’t only about generating an income for yourself. You may also want to leave money or other assets to the people who are important to you.

You might also find yourself supporting older parents, children or grandchildren during your retirement. Or perhaps all three!

A well-structured financial plan can help you balance these objectives with your own need for financial security and an enjoyable retirement.

Estate planning and the tax treatment of pensions and other assets can be complex, and the rules can change. Professional advice can help you understand how your retirement income strategy and your plans for passing on wealth fit together.

Talk to us about your retirement income

A secure and enjoyable retirement starts with understanding your options and putting a plan in place that reflects your individual circumstances and goals.

The earlier you start planning, the more time you have to consider your options and make adjustments.

If you’re approaching retirement and want to understand how to draw an income from your pension in a tax-efficient and sustainable way, talk to us today. We can help you explore your options and build a retirement income strategy designed around the lifestyle you want to enjoy.

Although the content of the article was correct at the time of writing, the accuracy of the information should not be relied upon, as it may have been subject to subsequent tax, legislative or event changes.