When determining how best to draw income from your investments in retirement, it’s important to consider both the funding of your own future needs, as well as the tax implications. Here are the key points to consider.

Working hard to build up your investments during your working life, and finding the balance between enjoying retirement and planning to mitigate the Inheritance Tax (IHT) payable on your death, can be a balancing act. On top of that, Income Tax and Capital Gains Tax needs to be considered when determining how to draw on your investments.

You may have built up a varied array of assets during your working life, such as pension plans, savings, including ISAs and other investment accounts or bonds, shareholdings and rental properties etc. For many of these sources, the income and gains will be subject to tax as they arise, with the exception of Individual Savings Accounts (ISAs), certain bonds and pension plans.

Pensions

Funds held in pensions at death are currently outside of the IHT net, but the changes announced in the Autumn Budget 2024 are anticipated to bring pension savings within the scope of UK IHT from April 2027. 

Up to 25% of your pension pot can be taken tax free during your lifetime and the remainder can be taken as income, as determined by you, or left untouched. Any funds taken out of your pension may be used for making a gift to your loved ones, but unless you survive seven years after making the gift, IHT may be payable. 

Aside from ISAs and some investment bonds, most other assets will generate income or gains that are taxed as they arise, while the income and gains within a pension fund will roll up tax free. 

From an estate planning perspective, prior to the announcement in the Labour party’s first budget, it was advisable to hold on to pension funds and instead, draw from other sources of income during your lifetime. However, the changes expected to take effect from April 2027 are seeing a shift in the strategy of drawing from investments in retirement. Each individual's position will, of course, depend on the make-up of their asset base, the tax treatment of their other income sources, and legislation at the time.

Investments 

ISAs

Funds in an ISA at death are subject to IHT, and this is a point that is often overlooked. Only transfers to spouses from ISAs would be free of IHT, and the surviving spouse may pass the funds into their own ISA by way of an additional permitted subscription. 

There is, however, one possible exception to this. It’s possible for shares listed on the Alternative Investment Market (AIM) to be held in an ISA, and provided the companies invested in qualify for Business Relief (BR) and the shares are held for at least two years prior to death, those investments may be removed from the IHT net. Advice should be sought before investing in AIM shares as these are generally considered higher risk from an investment perspective. To the extent an ISA is not being left to a spouse on death, and where BPR does not apply, it may be efficient to draw on the capital in an ISA in later life. It should also be noted that a £1m limit is expected to be introduced, in respect of assets which may attract BPR at 100%, from April 2026. Any value over that limit in an estate would receive relief at 50%. The £1m allowance will also be utilised by transfers in the 7 years prior to death.

Bonds

You may consider investment bonds because they offer the ability to withdraw up to 5% of the total invested, cumulatively, each year without giving rise to a tax charge. Any withdrawals in excess of the accumulated 5% allowances will give rise to chargeable event gains. 

Gains from UK bonds are taxed as the top slice of income and attract a 20% notional tax credit to cover the basic rate tax (but this cannot lead to a tax repayment). This means that tax is only payable on gains by higher and additional rate taxpayers. 

Gains on offshore bonds are added to the savings income and taxed as such, meaning the personal savings allowance and starting rate for savings can be applied to the gains. However, it’s rare for these bonds to qualify for the 20% notional tax credit. 

Investment bonds can also be placed in trust to take them out of the IHT net on death.

Investment properties

While property investments will provide a stream of taxable income, you may consider equity release as an option to draw capital from such investment properties.

Making the most of tax allowances

As important as it is to diversify investments, structuring the correct investment wrappers or products is equally as valuable to make use of all available tax allowances, minimising the tax payable on income and gains. It is surprising how low your marginal tax rate might be in retirement, the example below demonstrates this through simple planning:

• Utilise your personal income tax allowances (£12,570 each – £25,140 at 0% tax for a couple)

• Sell investments with up to £3,000 of capital gains (£6,000 at 0% tax for a couple)

• Receive dividends from investments or income (£1,000 each - £2,000 at 0% tax for a couple)

• Use savings allowance of up to £1,000 each for cash interest (£2,000 at 0% tax for a couple)

• Depending on your other income (e.g. pension withdrawals), use the starting rate for savings on cash interest (£5,000 each - £10,000 at 0% tax for a couple)

For a couple, that’s potentially a minimum £51,140 tax-free before we consider other sources of tax-free or tax-deferred withdrawals such as:

• 25% tax-free withdrawals from UK pensions

• ISA withdrawals

• Dividends from VCT investments

• Capital returns on UK Government Gilts

• 5% of capital withdrawals from investment bonds

It is optimal to try and keep the income elements for each individual below the higher rate tax band (£50,270) and certainly where possible (if within objectives) below the additional rate band (£125,140) or £100,000 to avoid the impact of the effective 60% rate of Income Tax – click here to find out why.

How we can help

While you may be keen to minimise the tax when drawing from your investments in retirement, it’s important to ensure your own standard of living is not compromised. Our tax and financial planning experts will work collaboratively to review your assets, create a tax-efficient financial plan and provide cashflow forecasting to help you understand the impact that your plans will have on your future. Our advice will be tailored to your unique circumstances, with solutions that not only provide options to minimise the tax, but also consider your future needs.