You’ve retired, you have a large pot of money and you get to decide what to do with it. Cha-ching! You can access this money once you turn 55 and can take out 25% tax-free as a lump sum. For the remaining 75% you have a few choices…

Option 1 – Go crazy! (We’re not big fans of this one)

Withdraw it all and party like it’s 1999. The bad news? Besides fancy dress from fashion’s worst decade it will be treated as income and if your pot is over £15,000 you'll pay income tax on a chunk of it. All those years of saving tax by building your pension pot goes down the drain! To avoid paying tax (or as little as possible) you need to plan how much to withdraw each year.

Option 2 – Pay yourself an income

Leave your money invested where it is with the expectation that the value will continue to rise and you can dip into this pot at any time to pay yourself an income. Because it’s your choice when you decide to take this money, you can pay yourself a yearly income in the most tax efficient way by staying within the government's lower tax brackets. FYI here are the income tax bands:

BandTaxable IncomeTax Rate
Personal Allowance*Up to £11,5000%
Basic rate£11,501 to £45,00020%
Higher rate£45,001 to £150,00040%
Additional rateOver £150,00045%

*If you earn over £123,000 a year, you don't get a Personal Allowance and all your income is taxed. 

Do I miss out on the 25% tax-free lump sum if I don't take it at 55?

No way Jose.  No one can force you to take money. You can keep it invested in your pension pot and withdraw from it at anytime. When you do withdraw, 25% of it will be tax-free. For example, if you withdraw £20,000, then £5,000 will be tax-free and £15,000 will be treated as income. 

How do I avoid paying tax on pension income?

Well, like we outlined above, you can take out 25% tax-free (as a lump sum or overtime). On withdrawals above this you have to stay within your Personal Allowance of £11,500. Here are two possible scenarios:

#1 Take out 25% as lump sum at the age of 55 and thereafter pay yourself £11,500 a year.

#2 Don't take-out the lump sum. Instead, pay yourself £15,000 a year and 25% of this (£3,750) will be tax-free under the pension rules and the rest (£11,250) will be tax-free under your Personal Allowance.

Side note: Planning on how much to withdraw will depend on the size of your pot, when you want to begin and how much you need. You may also be receiving other income (such as investments, rental income, part-time work) and when it comes to tax the government will look at the sum of ALL your income. This is where a one-off meeting with a Financial Advisor could come in handy. 

A £15,000 pension income doesn't sound like much...

You're right but the state pension kicks-in around 68 (if you're retiring after 2030), which currently amounts to £8,000 and your outgoings should be less - with the mortgage paid off, kids able to fend for themselves (here's hoping) and no expensive commutes to work. For other income you receive, there are yearly tax-free allowances for specific investments and, if you go over this, you can find tax-free wrappers such as a Stocks & Shares ISA

Option 3 – Guarantee a lifetime income

Give your pot of money to an insurance company and in return they’ll pay you a fixed sum of money each year. This is an insurance product called an annuity. The rates of annuities will vary all the time. Normally, when the economy is looking rosy the rates will be higher. So choosing an annuity is a matter of timing and also of shopping around insurance companies to get the best rate.

MOXI Round-up

Your choice will depend on your situation at the time of retirement and how big your pot is. You can check each option and decide which will get you the most moola. It’s key to avoid paying tax and that’s the trap. You could build a huge pension pot only to have to pay back 20% or 40% in your retirement. So, live with the reality that your pension payments are going to be less than your final salary and set up some other investments or securities in your life so you’re getting paid in more than one way. MOXI's suggestions: Pay off your mortgage, own a rental property or other investments.


You May Also Like

Saving vs Investing?
Use our tool to find the right balance for you.

Are You Ready to Invest?

Sign-up for even more money tips and the top trending finance news delivered straight to your inbox

I agree to Moxi Privacy Policy