How to make your pension last 20 years – and pay less tax



This option would leave a £4,311 shortfall if the retiree wanted to reach a £20,800 “moderate” standard of living, as defined by the PLSA.

Opting for drawdown can provide a higher level of retirement income, while using Isas and taking advantage of allowances can minimize the amount of tax paid.

Tom Selby, of fund shop AJ Bell, said: “You should consider the investments you choose to generate that retirement income. Investments that pay healthy dividends are popular among people generating an income through drawdown, allowing people to preserve their underlying capital.

“A ‘natural yield’ strategy – where you simply live off the income your investments generate – is one way to make sure your pot stretches longer, or you have more to leave to loved ones after you die. However, this can leave you open to big fluctuations in your income if dividends dry up, as we saw in 2020.”

How to make your pension last at least two decades

When you move into drawdown, you will have the option of taking 25pc as tax-free cash. The most tax-effective way to make a £355,000 pension pot last for two decades is to use a combination of this tax-free cash and taxable income to keep the amount drawn within the personal tax allowance, eliminating the need to pay income tax.

As this is pension income, it will not be subject to National Insurance or the new Health and Social Care levy.

  • At the age of 65, before the saver is eligible for state pension, they could take £8,230 as a tax-free lump sum and £12,570 of taxable income, the maximum allowed within the personal allowance and therefore not subject to income tax, according to revive
  • At age 67, when the saver is eligible for the basic state pension, taxable income taken can be reduced to £3,231, thereby ensuring that taxable income does not exceed the personal allowance
  • The amount of tax-free cash available will be exhausted in roughly 11 years, and thereafter the amount of taxable income taken will need to be increased to make up the deficit. Income tax will therefore be applicable.

Taking the income in this way would ensure that the pension pot does not run dry until the age of 99, assuming an investment growth rate of 3.5pc.

This advice is only applicable to those with emergency savings already in place, however. Sarah Coles of Hargreaves Lansdown, another fund shop, said retirees should work towards having one to three years’ worth of essential expenses in an easy-access savings account in case of emergencies.

In this case, some of the tax-free cash may need to be used to build up the emergency fund. Ms Coles suggested an alternative plan:

  • If the retiree already has savings in place, and takes the full £88,750 tax-free cash from the £355,000 pension pot, and is able to shelter it all in stocks and shares Isas over a few years, drawing 4pc would deliver £3,550 of tax-free income
  • They’d then have £9,339 of state pension, and draw £7,911 from their own pension. The first chunk of the pension income is free of tax, due to the personal allowance
  • If, by contrast, they need to use £40,000 of tax-free cash for emergency savings, they would only have £44,750 in the stocks and shares Isas, and they would need to draw £9,671 from their personal pension

What help is out there?

Savers can obtain free help from the Government service Pension Wise from the age of 50. Savers can also check to see how much state pension they are on track to receive and how it is calculated on the Government website gov.uk/check-state- pension.

Consolidating pensions early can help reduce fees and potentially increase returns. Robert Cochran of Scottish Widows, a pension firm, said: “People who change jobs frequently may have built up several different pension pots.

“Our research found that over 3.6 million Britons have no idea how many pensions they have and risk paying more in fees than necessary.

“It’s important to know where your pensions are and consider consolidating where this makes financial sense.”

This article is kept updated with the latest advice.


Reader Service: We should all try to save money for retirement but how can you tell what is a good pension pot?


www.telegraph.co.uk

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George Holan

George Holan is chief editor at Plainsmen Post and has articles published in many notable publications in the last decade.

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