Retirees with multiple income sources, including the state pension, workplace pensions, ISAs, savings and property, should coordinate withdrawals to minimise tax. This has become more important as pension tax rules change. From April 6, 2027, unused pension funds and death benefits will generally be included in the value of a person's estate for inheritance tax (IHT) purposes. HMRC estimates that 10,500 additional estates will now face an IHT bill, while another 38,500 will pay more.
Rethinking the old advice
Jemma Slingo, pensions and investment writer at Fidelity International, said retirees now need to rethink the old advice to preserve their pension for as long as possible. Currently, many people with both an ISA and a pension spend their ISA first. Now both will be subject to IHT, and the calculation changes.
“The new rules don't mean pensions have suddenly become poor savings vehicles. They remain the most tax-efficient ways to save for retirement for most people,” Slingo said. She added: “What the changes do mean is that the old ‘fund it first, spend it last’ rule is no longer right for everyone.” Slingo said your priority should be managing your own tax bill, rather than becoming too focused on what might eventually go to your beneficiaries.
Using your personal allowance
The annual tax-free personal allowance is frozen at £12,570 until April 2031, while the higher-rate threshold remains £50,270 (rules are different in Scotland). That creates an opportunity for those who retire before they are eligible to start taking their state pension. They may have years with little taxable income. Drawing some pension at this point puts your unused personal allowance to work.
Once you start claiming your state pension, it will use up much or all of your personal allowance. So your strategy may need to change. Defined contribution workplace or personal pensions, which invest in the stock market, allow 25% to be taken tax-free.
Spread tax-free withdrawals
Slingo warned against taking it all up front. The same goes for ISA withdrawals. “There is a strong temptation to rely on tax-free money early in retirement, either from your ISA or the tax-free part of your pension. Doing so can lead to more taxes in the long run, however.”
By spreading these tax-free elements over the years, you can potentially avoid getting pushed into higher tax bands later. So a combination of taxable pension income, tax-free pension withdrawals and ISA money could work well, depending on your circumstances.
Other allowances to consider
Michele Tieghi, founder of Psyfi Money, highlighted three allowances that retirees with investments and savings should keep an eye on. First is the Capital Gains Tax allowance. It’s been cut back, but you can make up to £3,000 of tax-free gains in 2026/27 without paying CGT. This applies to non-ISA shares, second homes, cryptocurrency and other assets. Above that, gains are generally taxed at 18% or 24%, depending on your tax bracket.
Next is the £500 dividend allowance, also reduced. Dividends above this are taxed at 10.75% for basic-rate taxpayers, 35.75% for higher-rate taxpayers and 39.35% for additional-rate taxpayers in 2026/27. Finally, there’s the Personal Savings Allowance (PSA). Basic-rate taxpayers can receive £1,000 of savings interest tax-free, while higher-rate taxpayers get £500. Additional-rate taxpayers don’t get a PSA.
These allowances aren’t huge, but using them each year can reduce your tax bill, Tieghi said. ISAs are even better, as all interest, dividends and gains are sheltered from tax.
Beware of taking too much too soon
The key point is to examine all of your income. A large one-off pension withdrawal will be added to your other taxable income and push you into a higher tax band. You should also be wary of taking too much too soon, which can leave you short in later life. Pension freedoms began in 2015, and some 2.4 million have taken a taxable pension withdrawal before the age of 65. That’s seven in 10 of those who have taken taxable payments, analysis by Lumera found.
Peter Roos, chief commercial officer at Lumera, said accessing a pension early can have serious consequences. “If you’re working, it can push you into a higher tax band.” It can also trigger the Money Purchase Annual Allowance, cutting the amount you can subsequently contribute to a pension with tax relief from £60,000 to £10,000 a year. Taking money out earlier also means losing the potential investment growth, Roos added. “That leaves a smaller pot to support what could be several decades in retirement.”
So there’s no single magic order for taking your retirement income. Your state pension, pension pots, ISAs, savings and investments all need to be considered together. Professional financial advice can be valuable, particularly if you have substantial pensions, investments or a potential IHT liability. At the very least, use the Government’s Pension Wise service. It offers free, impartial guidance on taking a defined contribution pension, including the different ways you can take the money and how each option is normally taxed. You can access Pension Wise through MoneyHelper online. The service can also be contacted on 0800 138 3944.
