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Tax-efficient retirement strategies
When it comes to the thought of retirement, probably the last word that creeps into our mind is “tax”. Why should it? Retirement is a time to think about all of the things that you have always wanted to do with the money you have worked hard to earn.
However, the unfortunate truth about retirement is that there may still be tax to pay and it's important to understand the different taxes that may apply to you and how they will affect the actual income you have to enjoy in retirement.
With proactive financial planning and a clear understanding of your allowances and options regarding how you draw down on your wealth, you can take steps to minimise the amount of tax you pay and keep more of your hard-earned money.
Understand your allowances
During retirement it’s likely that you will start drawing an income from various sources. Like any income that you were drawing whilst employed, retirement income may still be subject to income tax.
In the UK everyone has a Personal Allowance, meaning that you do not pay tax on the first £12,570 (tax year 2025/26). Most income above the Personal Allowance is subject to income tax at 20%, rising to 40% above £50,270 and 45% above £125,140. It’s important to understand which tax band your total income places you in and how any new sources of income could push you into a higher bracket.
Maintain savings tax efficiently
Part of any good, solid, financial plan is having enough cash, even in the environment we find ourselves in now, where rates are gradually reducing from the highs of the last few years. Drawing on your available cash reserves can be a tax efficient way of generating a retirement income.
The reason why drawing cash could be a way to save tax is that most withdrawals that you make from a bank account or building society are tax free, provided that any interest that you have earned on your savings does not exceed the Personal Savings Allowance.
The Personal Savings Allowance (PSA) entitles you to £1,000 tax-free interest if you are a basic-rate taxpayer and £500 tax-free interest if you are a higher-rate taxpayer. Any interest that you earn as an additional-rate taxpayer is taxable. If your savings interest might exceed your PSA, using a Cash ISA can help shelter those funds from tax.
For those with an income from wages or pensions of less than £17,570, you may also be eligible for up to £5,000 of interest and not have to pay tax on it, in addition to your PSA. This is your starting rate for savings.
For more information about how this works, take a look at our article ‘How much savings interest is tax free’.
Utilise ISAs effectively
Investment income can be taxed in slightly different ways depending on what income tax band you fall into and what type of income it is, such as dividends or interest. However, one way that you can avoid an unnecessary headache of tax being taken on your investments is to consider a Stocks & Shares ISA.
Stocks & Shares ISAs are also hugely beneficial from a tax perspective as any capital gains, interest or dividends that you earn on your investments are free from tax. Any withdrawals from Stocks & Shares ISAs are also free from tax, contrary to pensions, which we will move on to a little later.
You can currently contribute up to the ISA allowance each year, which is currently £20,000. This is the amount that you are allowed to contribute, in total, each year. Bare in mind it's the total you can contribute across all available ISAs, such as a Cash ISA or Lifetime ISA
For example, someone with £100,000 invested in a Stocks & Shares ISA who earns £4,000 a year in dividends would pay no tax, whereas the same income held outside of an ISA would exceed their dividend allowance and may be partially taxable.
Plan your income withdrawals carefully
Contrary to money drawn from an ISA, money drawn from a pension may be liable to income tax. The tax that you may pay on your pension depends on a broad range of factors. You first need to identify the type of pension scheme that you are enrolled in, and then you’ll need to establish what options you have available to you in accessing your benefits and determining ways to reduce the tax you might pay.
If you have a Defined Benefit scheme, sometimes referred to as a Final Salary pension, then typically you will receive an increasing income for the rest of your life. As you might expect, if you are receiving a fixed level of income each year then there isn’t much wiggle room if you want to reduce your income tax bill. If your income needs are higher than what you are receiving, then you could consider drawing on cash or investments as an additional source of tax-efficient income.
In comparison, if you have a Defined Contribution pension there may be more flexibility on how you can draw an income from your pot, but each has different tax consequences. Some pensions offer the full range of options in accessing your pension, but some schemes do not. If your scheme does not offer the full range of options in accessing your pension benefits, this could be detrimental to you. This inflexibility could result in you paying too much tax during retirement and not allowing you to plan accordingly using your allowances and adapting to your change in circumstances and needs.
Despite the differences between Defined Benefit Schemes and Defined Contribution Schemes there is normally one similarity between the two, and that is the ability to take a tax-free lump sum from your pension. Current legislation permits that for individuals in a Defined Contribution Scheme, the maximum tax free cash sum is the lower of 25% of the total pension value or the available Lump Sum Allowance of £268,275 (there are some exceptions to this). For a Defined Benefit Scheme the available Lump Sum Allowance remains the same, but the maximum tax free cash sum depends on the scheme’s own calculations.
For instance, someone with a Defined Contribution pot of £200,000 could take £50,000 tax free and then structure the remaining withdrawals over time to stay within the Personal Allowance. This strategy could ensure you are using your allowances, planning tax efficiently and ultimately mitigating any tax liability for you.
Our ultimate tips here are to firstly find out what type of scheme you are in. Then secondly, to understand how you can access your pensions and what flexibility on this they offer. Finding out all the options will help you decide when you should be drawing on your pensions in conjunction with your other assets in order to minimise the tax you might pay and optimise your retirement income strategy.
Factor in your State Pension
Finally, no discussion about retirement income could be complete without stressing the importance of the State Pension. For most people, the current State Pension will be paid from age 66 (increasing to 67 which will be fully phased in from 2028 for those born on or after April 1960. Then expected to rise to 68 in 2044-46).
The State Pension can provide a valuable source of retirement income to help you meet your expenditure needs. However, it’s important to stress that coupled with any other income that you are receiving, the State Pension could push you into a higher income tax band.
Our tip here would be to check what other income you may draw upon when your State Pension kicks in. Having an idea of what other income sources you are drawing upon in conjunction with your State Pension, will then help you understand whether you could draw from a more tax efficient source later in life, such as savings or investments.
Devising a plan
At The Private Office (TPO) we have vast experience in designing financial plans for our clients. Central to any financial plan is ensuring that you maximise your wealth to achieve your goals. We have a dedicated team who specialise in retirement planning and ensuring that your wealth works as hard as possible for you and that you are minimising tax where possible during this next stage of your life.
If you are looking for help and advice regarding your own personal finances in these uncertain times, we are offering anyone with £100,000 or more in savings, investments or pensions a free consultation. Why not get in touch and speak to an adviser.
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The Financial Conduct Authority (FCA) does not regulate cash flow planning, estate planning, tax or trust advice.
This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.
The value of your investments can go down as well as up, so you could get back less than you invested.
This article is also based upon our understanding of current law, HM Revenue and Custom's practice, tax rates and exemptions which are subject to change.
A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can go down as well as up which would have an impact on the level of pension benefits available.
