I am aged 66 and have a pension pot of £120,000 which I don’t anticipate needing for at least the next five years. Would it make sense to draw it down in a tax efficient manner (avoiding the higher rate tax band) over the next three years and reinvesting it in both mine and my wife’s Stocks and Shares ISAs? Thereby reducing my tax liability further down the line (subject to me living that long of course)?

R. Dunkley, Cumbria

Tom Selby, AJ Bell Head of Retirement Policy, says:

Before we get into the bones of your question, let’s do the usual jargon busting. In pensions, when we talk about ‘drawdown’, this just means keeping your pension pot invested while taking a retirement income.

In order to take an income through drawdown, you need to ‘crystallise’ your fund (or part of your fund). This just means choosing a retirement income route. Upon doing this, provided you haven’t already used up your tax-free cash entitlement, you will also unlock your 25% tax-free cash (or a portion of your entitlement).

For example, if someone had a £100,000 pot, they could choose to crystallise the full pot, with £75,000 put into drawdown and the remaining £25,000 paid out as tax-free cash. When you access your pension through drawdown, your withdrawals will be taxed in the same way as income.

When deciding whether to take money out of a pension, it is important to carefully consider all the tax implications of that decision. Taking small withdrawals regularly from your pot to fund your spending needs in retirement can be a sensible strategy and should reduce the amount of income tax you pay.

Let’s go back to our example of the saver with a £100,000 fund who has crystallised £75,000 in drawdown. If they took the entire £75,000 and had no other income, in 2023/24 they would face an income tax bill of £17,428.

If, however, they took the £75,000 in three equal chunks of £25,000 each tax year, they would pay income tax of £2,484 a year, or £7,452 over the three years (assuming income tax rates and bands stay the same) – almost £10,000 less than taking the whole lot in one go.

If, however, the money was taken out of a pension and reinvested in another savings product, such as an ISA, it would become subject to inheritance tax (IHT). This would mean that any funds over your IHT allowance could be subject to a 40% IHT charge.

Money held in a pension, on the other hand, can be passed on tax-free to your nominated beneficiaries if you die before age 75. If you die after age 75, your beneficiaries will only pay income tax on the inherited pension when they access the money.

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to asktom@sharesmagazine.co.uk with the words ‘Retirement question’ in the subject line. We’ll do our best to respond in a future edition of Shares.

Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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