Pension withdrawals: four tax-free ways to access your retirement savings

Financial planner Dan Woodruff explains how pensions have changed and the best strategies for withdrawing money, whatever your situation.

Introduction to withdrawing pensions

If you want to access your flexible pensions for capital or income, you should think carefully about how to access your money.

This article explores six strategies used for pension withdrawals. Our expert strategies – options 2, 3, 4 and 6 – can help you get tax-free withdrawals

Options 1 and 5 will mean you pay more income tax and should only be used in very specific situations.

We follow one hypothetical client, ‘Sarah’, through her pension income choices, exploring some common scenarios. For this article, we have used a pension fund valued at £300,000 to show the strategies set out below.

In each scenario, Sarah is assumed to have different needs, which highlight why she might use each of the strategies. Sarah is aged over 55, so she can access her pensions flexibly.

Of course, the tax you pay on your pension withdrawals is only part of the story. You should consider many other aspects when taking withdrawals from your pension, which is why we recommend that you take financial advice from a pensions expert.

There’s also a video running through the key points from the article.

Before you begin, please note that the tax allowance figures mentioned here applied in 2017 and have now been increased. This doesn't affect the strategies mentioned here, but you should check recent figures before making any calculations.

How pensions have changed

There are a wide variety of solutions available for you when taking pension withdrawals. Here we explore the 2 main pension income options, for comparison.

Guaranteed pension annuity – the traditional pension income

You would choose this pension income method if you want certainty over your income, no matter what happens.

A guaranteed pension annuity allows you to swap your pension fund for a guaranteed, taxable income for life. You get to choose the tax-free lump sum you want, and then invest the remaining fund into the pension annuity.

The income will be set up according to the features you choose, but the main choice is whether you want your income to start higher at first, but never increase; alternatively, your income can start lower, but increase annually in line with inflation, or a constant growth rate.

A pension annuity is still the right choice for many people since it can provide you with a guaranteed income for life. The main benefit is certainty, but the downside is that you do not get to change your income once the plan is set up.

In addition, unless you pay for extra benefits, the income will die with you. Unfortunately, the only way you can use an annuity for tax-free pension withdrawals is to take the tax-free lump sum.

Using flexible pensions for tax-free pension withdrawals

The flexible pension rules allow you to treat your personal pension more like an ISA, once you reach age 55.

The complex pension rules still exist, but you can now withdraw as much as you want, subject to tax, at any stage. This is very useful if you want control with flexibility and are prepared to take some risk over your future.

Flexible pensions work well if you have some other sources of income, and you do not need guaranteed income. You can also pass on your remaining fund to your family after you die.

The downside is that flexible pensions are more complex. You take risks with your investments, and you might outlive your fund and possibly run out of money.

How pensions are taxed

Option 1 – full withdrawal with tax

Option 2 – full tax-free lump sum

Option 3 – partial tax-free lump sum

Option 4 – tax-free income

Option 5 – traditional drawdown income with tax

Option 6 – tax-free flexible income

Tax-free pension withdrawals – general principles

Clearly, flexible pensions and tax-free pension withdrawals can be a complex set of arrangements. We recommend that you seek financial advice before making any changes to your pensions as withdrawals can have unintended consequences further than the issues covered in this article. You should think about these general principles:

What is the money for? Do you need a lump sum for a specific need, or income to fund your lifestyle?

Will you spend it? The default choice should be to leave your pension fund alone until you actually need to spend the money. Pensions grow tax-free, so any withdrawals need to be spent, or you risk paying tax on the withdrawal, plus tax on the capital once it is outside your pension plan.

Do you have other sources of income? This article ignores the effect of other income sources such as other pensions, property, or savings. Think about how much income you need, when you need it. Perhaps you could use your tax-efficient pension withdrawals to fill in gaps from other income sources.

If you want to learn more about retirement planning, read our comprehensive guide to pensions.

Dan Woodruff is a certified financial planner and chartered wealth manager. You can read more of his advice and contact him on Woodruff’s website. The views expressed in this article do not necessarily represent those of loveMONEY.