Money is complicated once you reach retirement because spending the wrong savings first could make you worse off by sparking a tax bill.
Although 25% of pension savings come tax free, inadvertently withdrawing too much from your pot could push you into a higher tax bracket and diminish your spending power.
It’s likely that as a saver you have more than one source of retirement income.
This could be one or more pensions, an ISA and cash in the bank.
You can make this cash go farther by spending the right money first.
Rather than pay income tax on taking cash out of a pension, spend money stored in an ISA or bank account first.
Cash and ISAs first
The bank account is the favoured first call because the rate of interest earned is probably much lower than cash in an ISA or pension is earning.
The money is also tax-paid – you handed over a slice of your stash as tax before putting the cash in the bank and no more tax is due.
Next, dip into the ISA.
Like bank savings, ISA cash grows tax-free and costs nothing to withdraw and spend. Don’t just move the money into the bank if you do not have it earmarked for spending as the cash will still grow faster in the ISA.
Even if your cash savings and ISA withdrawals added together come to more than the higher rate tax bracket threshold, you will not pay any more tax when take the money.
Pension pot withdrawals
Once your cash and ISA are exhausted, it’s time to look to freeing some of your pension pot.
Although that 25% lump sum is tax free, you do not have to take the money in one go. You can spread the withdrawals if you wish.
You will pay income tax as you take money from your pension pot because your state pension and earnings from dividends if you have them will take up most of your tax-free personal allowance.
The allowance is £11,500 and is set to rise to £12,000, while the state pension is just below £8,300 a year and is likely to rise by 2.5% next year, so that does not leave much headroom for taking money while avoiding tax from a pension.