Whether you are in retirement or shortly approaching it, or it still lies some way in the future for you, it can be tempting to assume that you go to your pension first as your source of income in retirement. But beware – taking income from your pension first could mean that you are losing out on significant disposable income.
Many people arrive at the age they want to partly, or fully, retire with a range of assets. These can include cash, property, ISAs, bonds, pension plans such as SIPPs, and maybe some multi asset funds or other investments. As a result, you will have a choice of where to take your income from first. But it’s likely that the best choice is not your pension.
Why is this? Well, it can be complicated. Which is why it’s a good idea to have a qualified financial adviser whose job it is to optimise how you take your income. But to give a simple example:
- Tax rate on your income from your ISA – 0%1
- Tax rate on your income from your other investments – normally Capital Gains Tax at 20%, and
- Compared to the tax rate on your income from your pension – Income Tax at 20%, 40% or even 45% depending upon your income2. These rates are different if you are resident in Scotland. 3
This too is another benefit in organising your retirement income to come from several different pots at different times. It can be a good idea to take more investment risk on the portion of your money that you don’t need immediately. This is because you are more likely to get a higher return on it on average, plus it stays invested longer for that higher return to compound. And it can be even more efficient if this is in a pension because the compounded growth is not taxed.
However, along the way there will be times when investment markets are down, and you don’t want to be to having to sell these investments to take income at such times, which would result in temporary losses. That’s why it’s usually a good strategy to take the higher investment risk only with the money that you are sure you aren’t going to need in the short term and have your ‘essentials’ money come from cash or short-term deposits.
So, it’s about organising your ‘pots’ not just in the most tax efficient way, but in a way which optimises the balance of investment return, investment risk, and timescales for when you will need the money.
Other factors to consider once you come to take income from your pension (especially if you have more than one pension, and a spouse or partner who has pensions too), include; your respective ages, how much to take of the tax-free cash allowance, what to leave in flexi access drawdown and with which provider, inheritance tax (IHT) implications, whether and how you can get access to your capital, and death benefit flexibility.
Factsheet – Making the most of your tax allowances and reliefs
Our downloadable factsheet can be accessed here – for general information which will become more relevant once in retirement.
Your financial adviser will be able to provide guidance with all these tax savings opportunities and provide advice tailored to your personal circumstances. If you’d like to learn more, please get in touch now.
The value of pensions and investments can fall as well as rise. You may get back less than you invested.
Tax treatment varies according to individual circumstances and is subject to change.
Approver Quilter Financial Limited. 30/10/2023.