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How to work out your income in retirement

Written by: Paloma Kubiak
For people approaching retirement who have a number of possible income streams, it can be difficult working out how much you need and the tax implications of drawing on your money.

It’s a simple enough question for those approaching retirement, but working out exactly what income you’ll have – or need – for a comfortable later life can be a complex area to navigate.

People who’ve worked all their adult lives, saved their hard-earned money and dabbled in the stock markets now need to focus on how to draw on these sums in the most tax-efficient way.

Below we outline five of the most common income streams and how people approaching retirement can work out what level of income they might provide, as well as the most tax-advantageous ways of drawing on their money:

State Pension

The new State Pension (or flat rate pension) came into effect in April 2016. It’s based on your date of birth so that all men born after 6 April 1951 and all women born after 6 April 1953 who reached retirement on or after 6 April 2016 fall under these rules.

To qualify for the new State Pension, people need at least 10 years of National Insurance Contributions. To receive the full amount (currently £159.55 per week), you need 35 qualifying years (you can get a record of your NI contributions from HM Revenue & Customs).

However, not everyone approaching retirement will get the full weekly amount, according to Simon Nicol, pension principal at Thomas Miller Investment, which is why it’s important to check your State Pension forecast via the government site.

He says: “Not everyone will get the full amount, such as those who are contracted out so it’s worth finding out what that figure is. For those approaching retirement, it is possible to contribute more to increase that amount.”

Nicol adds: “You get the state pension regardless of any other financial circumstances. If you don’t need the capital immediately, you do have the option to take it at a future date.”

For those deferring their state pension, the amount increases by the equivalent of 1% for every nine weeks you delay. This works out at 5.8% for each full year. See’s guide on Deferring your State Pension for more information.

Private and/or workplace pension

Under the government’s flagship Auto-enrolment scheme, millions of people are contributing to a workplace pension – currently the minimum pension contribution is 1% from the employer and 1% from the employee, meaning a 2% total contribution. As well as contributions from the employer, the amount also attracts tax-relief at your usual marginal rate of tax (20%, 40% or 45%).

People may have also opted for a private pension, such as via a Self-invested Personal Pension (SIPP) or Small Self-Administered Scheme (SSAS), or you may have a final salary (DB) scheme.

As you approach your State Pension age, you should get a statement around six months before showing what’s in your pension pot. Most schemes these days will have an online portal to check the value.

Under the Pensions Freedoms which came into effect in April 2015, anyone aged 55 and over (those with a money purchase or defined contribution pension) can take out a 25% tax-free lump sum.

Nicol explains that the tax-free pension lump sum doesn’t affect your Personal Allowance (the amount you can earn without a tax charge) which currently stands at £11,500. He says: “If you don’t need the lump sum, under a money purchase scheme, you can defer taking that amount rather than simply keeping it in the bank. Instead you can take out a proportion of income as tax-free cash.”

For those opting for pension drawdown, you can use the tax-free cash rather than drawing down on the taxable income part. This can be particularly helpful for those who are pay higher rate tax in the tax year in which they retire. Nicol explains: “If you have the option, you may be able to defer taking further taxable income in that tax year. With no employment income the following tax year, this may well mean they’re a lower rate tax payer. This could be done by for example utilising a bit of tax free cash to tide them over until April.”

A final point from Nicol is that pensions are not part of your estate upon death. “When you die and leave money in a pension, there’s no inheritance tax. People’s inclination is to use their pension first for retirement income, but from an IHT perspective, it’s more tax-efficient to use up your non-pension capital first.”

ISAs and cash deposits

ISAs are one of the most tax-efficient vehicles for savers. While rates available on easy access and fixed rate deals have been in the doldrums, one of the major advantages is that any income and capital growth from an Isa is tax-free. The current annual limit is £20,000 and it is possible to build up a reasonable tax-free income stream over time.

According to Nicol (see the graph below), for a cash Isa, a variable income of between 0.5% and 1% gross income can be targeted without depleting the original value of the fund. With a stocks and shares ISA, Nicol estimates between 2% and 3% gross income can be targeted, again without depleting the value of the core fund.

For cash savings, the Personal Savings Allowance was introduced in April 2016. Basic rate taxpayers who earn up to £45,000 will be able to earn up to £1,000 of savings income without any tax being due. Higher rate taxpayers (40%) who earn up to £150,000 will get a £500 allowance, but additional rate taxpayers (45%) who earn above £150,000 are not eligible.


The tax-free dividend allowance will be cut from £5,000 to £2,000 from April 2018. The government estimates around 2.27 million people will be affected with an average loss of £315 for shares or funds held outside of an ISA or pension.

Currently any dividend income above the £5,000 allowance is taxed at the following rates:

  • Basic rate taxpayer – 7.5%
  • Higher rate taxpayer – 32.5%
  • Additional rate taxpayers and trustees – 38.1%.

Rental income

The income tax incentives aren’t as attractive as they once were. Buy-to-let mortgage interest relief is being phased out progressively and will be replaced with a 20% tax credit by 2020. This will largely affect those paying higher rate tax, though it may push some basic rate tax payers into a higher tax bracket. If you have been letting for a while, you may have losses that you can carry forward and set against profits. You should also note that you will pay capital gains tax on buy-to-let properties.

As the tax position on rental income has become very complicated, landlords and BTL investors should take advice from a tax expert. A lot depends on your other income/investments/properties. If someone has no other income they can receive up to £11,500 in rent (the Personal Allowance threshold). If you earn more than £11,500, then your rental income is taxed at your usual level, basic or higher. Rental income may push you into a higher tax band.


Source: Thomas Miller Investment

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