Maximising tax-free income in retirement

One of the key areas we look at with clients is structuring income in retirement. With life expectancy at an all-time high, many people underestimate how long they’re going to live. Unless you have a guaranteed income for life you need to make sure you have enough to live on for the whole of your retirement, whilst considering the most tax efficient way to achieve this.

This can be a daunting task. While everyone’s individual circumstances will differ and bespoke advice should be sought, here are some key areas to be consider:

How much do I need?

The first step is to figure out how much income you’ll require to fund the kind of life you’ve enjoyed to date. Start with the basics such as groceries, clothing and bills. Then factor in the kind of things that are going to make your retirement what you want it to be such as holidays, gifts and hobbies.

Once you have a good idea of what you’ll need, consider any guaranteed income you may be entitled to and when this will start. This might be a Final Salary scheme or the State Pension for example. Don’t forget you can check your State Pension forecast by visiting https://www.gov.uk/check-state-pension. This will allow you to identify what you may need to supplement from your other reserves. Remember to think about how you are going to fund your lifestyle if retiring before your guaranteed income kicks in and how much you will need to supplement any shortfall.

Planning a flexible and tax-efficient income in retirement

New pension flexibility can bring complications and confusion. Your pension income is taxable just like any other income and no one wants to pay more than is necessary. Working out when and how much money to take tax efficiently from various reserves can be complicated. Most people initially drawing down on their pensions will be eligible to receive 25% of the fund tax free. This is often taken as a lump sum but could, equally, be taken over a number of years to provide a useful form of tax-free income whilst leaving the remainder of the pension in place to grow.

Example

Take Mr and Mrs Daly as an example. They are both 60, have just retired and have accumulated various savings and pensions over their lifetimes. They want to know how they can structure their income in retirement in the most tax efficient way possible.

                                                          Mrs Daly             Mr Daly

ISA/ Cash reserves:                       £125,000            £125,000

Pension pots:                                 £250,000            £250,000

Assumptions:

Both are entitled to a fully funded State Pension at age 66

Annual Income requirement: £36,000 (£18,000 each)

Full personal allowance available at £12,500 each

Inflation per annum: 3% (in reality this may be much lower)

Growth rate: 5% (2% net after inflation)

Age 60-66

Personal Pension Plan Withdrawal:                       £12,500

Personal Pension Plan Tax Free Cash:                    £  4,167

ISA/Cash withdrawal:                                                £  1,335

= Total Desired Income                                            £18,000

By each taking a withdrawal from their pension of £16,666, this utilises their personal allowance of £12,500 as well as receiving an additional 25% tax-free cash of £4,167. They can then subsidise the remaining shortfall of £1,335 from their cash reserves, meaning that they can achieve their desired income tax free.

Age 66-99

State Pension                                                              £  9,000

Personal Pension Plan Withdrawal:                       £  3,500

Personal Pension Plan Tax Free Cash:                    £  1,166

ISA/Cash withdrawal:                                                £  4,334

= Total Desired Income                                            £18,000

At age 66, they are eligible to receive the State Pension. This is a great boost to their income and things can now be restructured accordingly. The State Pension income will leave £3,500 of their personal allowances remaining. This, again, means that by taking income from their pension pots they can utilise this tax-free amount. Remembering that 25% of the withdrawal will be tax-free, they can withdraw £4,667 each. This leaves an overall shortfall of £4,334, which again can be taken from their ISAs or cash savings.

In this example, based on the assumptions used, Mr and Mrs Daly will exhaust their savings by age 99.

Structuring the Daly’s income this way means that, over their entire retirement of approximately 40 years, they will have no tax to pay. While everyone’s situation will be different and individual advice should be sought, the above is an example of how we can help clients with planning their retirement to provide them with the life they dream of and the peace of mind that they can afford it.

If you would like help in understanding how you can structure your income efficiently, please don’t hesitate to contact us to arrange a complimentary initial meeting.