Changes introduced in 2015 opened up the option of accessing Defined Contribution pension savings more flexibly, in either lump sums or through income drawdown.
Meanwhile, the amounts that can be saved into ISAs - ‘Individual Savings Accounts’ where capital growth and withdrawals are tax-free - has been expanded so that we can each put £20,000 into an ISA each tax year, making ISAs a viable alternative home for retirement savings.
For those with both Defined Contribution pension savings and ISA savings - where should their retirement income come from? Which money should they spend first, and which should they keep untouched for longer?
The answer depends on an individual’s circumstances, but here’s a few things to bear in mind if you’re unsure how best to take an income from your retirement savings.
Do you need your retirement money before age 55?
If you want to live from your savings before age 55, a pension is probably not the best place to look.
There are some older pensions that allow access to your money before then and some can allow it if you suffer ill-health, so check with your provider to see it that applies in your case. Generally speaking, however, pension money cannot be accessed before age 55. If it is, the withdrawal will be classed as an “unauthorised payment” and will attract a hefty 55% tax charge.
ISAs come with no such restrictions on access.
Would you like to keep contributing to a pension?
You may want to start using your retirement savings before you have stopped earning an income from work. If so, bear in mind that pension rules may restrict what you can go on to contribute once you have accessed your pension pot.
If you have accessed pension money beyond the 25% that is generally allowed tax free, a limit is imposed on what you’re allowed to contribute from that point onwards without a tax charge applying. This is known as the Money Purchase Annual Allowance. For the current tax year the limit is set at £4,000.
The exception to this is Defined Contribution pension pots that, on their own, add up to less than £10,000. These can be withdrawn without the Money Purchase Annual Allowance then applying.
Will you face inheritance tax?
ISAs and pensions are treated very differently when it comes to passing them on after death.
ISA money can be inherited by a spouse or civil partner tax-free, but beyond that it will fall within your estate for Inheritance Tax purposes. So money left to children could be caught, for example.
With pensions, die before the age of 75 and anything in your defined contribution pensions can be passed on to anyone you wish and the recipient won't have to pay tax on it, as long as this is done within two years of the date of death. The money is not normally part of your estate, so no inheritance tax is due.
If death occurs after age 75, then the recipient must pay income tax on the money when they withdraw it.
All this means that it can make sense to withdraw ISA money and leave your pension pot intact if you fear an Inheritance Tax bill.
Do you face a jump in income tax?
When arranging your retirement income, you should always have an eye on tax. The objective is take the income you need while creating the smallest income tax bill you can - and balancing income from pensions and ISAs can help.
We all have an amount of income that we can earn each year without paying income tax: the Personal Allowance. It is set at £11,850 for 2018/19. By being smart with how you use your pensions and ISAs, you can earn even more without tax applying.
For example, a person entitled to the current maximum State Pension would receive £8,546 a year. That leaves £3,304 of their Personal Allowance to be used before tax starts to accrue.
It is then possible to take a lump sum from a Defined Contribution pension, of which 25% is tax free. This is one of the options to access your pension money now available.
If a £4,405 lump sum was taken, £3,304 of it would count against the remainder of the Personal Allowance, so would not be taxed, while £1,101 is tax-free anyway.
So, overall, a total of £12,951 of income has been generated without any tax being due.
If more income is needed, ISA money can be taken tax-free.
It is also possible to take larger lump-sums from a pension by withdrawing all or part of the 25% tax-free amount, while leaving some or all of the taxable 75% within the pension. Tax only becomes due once it is withdrawn. That means that, should the level of income you need fall, as can happen in later retirement, the tax bill on this money will be lower.
Balancing ISA and pension income in this way is useful if your level of income risks pushing you into a higher tax bracket. By making maximum use of tax-free pension money and ISAS, and thereby delaying the point at which you start using taxable pension income, you give yourself a better chance of reducing your income tax bill.
The Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.pensionwise.gov.uk or over the telephone on 0800 138 3944.
Fidelity’s Retirement Service also has a team of specialists who can provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge.
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not normally be possible until you reach age 55. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.
Combining your pensions into a SIPP can make it easier to manage your savings - and it could be cheaper, with lower service fees than you’re currently paying.