Retirement should be a time to relax, but many pensioners have to work hard to ensure their pension and other savings last the distance. As life expectancy rises, growing numbers will spend 20 years or more in retirement and need to manage pension withdrawals carefully. This has never been easy. One risk is that people withdraw too much too soon, leaving little or nothing for later.
But there is another risk. If people are too careful at the beginning of retirement, they will not make the most of it, so it is a difficult balance. Inevitably, there is something else to worry about, in the shape of HMRC. Once 25% tax-free cash has been taken, pension withdrawals are added to your total earnings from every source and subject to income tax.
Those who take a large lump sum in one year risk being pushed into a higher tax bracket and paying more tax. Antonia Medlicott, founder of financial education specialists Investing Insiders, said it is important to plan carefully before drawing down cash, especially with the personal allowance frozen at £12,570 all the way to 2031.
From next year, the full new state pension is likely to exceed this, making any further sources of income liable to tax, except pension tax-free cash or an ISA. "Almost everything you withdraw from your pension will be taxed at a 20% rate, rising to 40% if your income goes beyond the £50,270 threshold. This is something that many people forget."
Many also overlook the little-known but simplest and most effective way to reduce their tax bill. "If you have a partner, that means two personal allowances. If one of you has a lower income, you can spread the withdrawals between the two of you." This way, you can keep track of how close you both are to tax thresholds and avoid paying higher rates of tax.
It may be worth doing calculations to make sure your money lasts, she added. "With a £600,000 pot growing at 4% a year, withdrawing £25,000 a year will still leave you with £488,000 after 30 years. Increase withdrawals to £30,000 a year, and you will be left with £196,000." Medlicott said that for most people, annual withdrawals of between £25,000 and £32,500 are the sweet spot. "This allows you to enjoy a comfortable standard of living whilst remaining under the dreaded £50,270 higher-rate tax bracket."
Pension rules regularly change, so keep abreast of them. From April 2027, direct contribution pensions will come liable to inheritance tax, depending on the total value of the rest of your estate. Take this into account when planning withdrawals, potentially taking more pension if this will reduce your overall IHT liability.
Medlicott said that building up a Stocks and Shares ISA alongside your pension is one of the smartest investment decisions you can make. ISA withdrawals are entirely free of tax, so you can use them to top up your retirement income without handing more over to the taxman. "This is one of the most impactful and straightforward strategies available, yet it is far too underused," Medlicott said.
