How the average retiree could earn over £50,000 in tax free income

1 June 2022

With the cost of living crisis in full swing, more pensioners are having to tighten their purse strings and dip further into savings to help make ends meet. When doing so, it is important that you make the most of your tax allowances to ensure you are making your money go as far as possible. For those entering retirement now this will be vital, as making retirement income stretch will be a real concern.

According to calculations from Quilter, someone entering into retirement with average size pension pots and ISA savings could draw more than £50,000 a year across a range of different investments before paying any tax. Given the rising number of people feeling the squeeze on their everyday finances, it is vital that retirees make the most of their money and avoid paying any more to the taxman than is necessary.

A recent report from the Office for National Statistics (ONS) on ‘The rising cost of living and its impact on individuals in Great Britain’[1] revealed that around 9 in 10 adults reported an increase in their cost of living over the previous month in March 2022, a substantial increase of 25 percentage points compared with around 6 in 10 adults in November 2021. Additionally, the ONS found[2] that the cost of living crisis was disproportionately impacting older adults. In early 2022, a greater proportion of older adults reported their cost of living had increased compared with younger adults.

Retirees should always plan carefully when thinking about how to access their funds during retirement, and this is all the more important when their savings will need to stretch that bit further than normal. Being aware of and making full use of the allowances available can save retirees a substantial amount of tax money in the long term.

Here’s how the average retiree could generate £51,569.31 tax free income:

By making use of these tax allowances, the average retiree could draw a total of £51,569.31 or more depending on the PCLS, ISA, cash and 5% bond withdrawals taken.

Understanding the tax allowances available to you can make a considerable difference to your income. For example, recent government data[5] shows that on average, over 65s have around £52,590 in an ISA. If a pensioner with this level of ISA savings planned for a 16-year retirement up to the average life expectancy – 65-81 years old – they could comfortably withdraw £3,000 a year tax free to top up their income.

Additionally, if they were in a position to take their PCLS and wanted to do so, they could increase their income for the year significantly. The latest retirement income market data from the FCA shows that after a lifetime of saving, the average UK pension pot stands at £62,797.25[6]. If they had an uncrystallised pension of this value and decided to go into drawdown, they could opt to receive an upfront PCLS payment of up to £15,699.31. If this was the case, their income could reach a total of £51,569.31 or more.

However, it is important to remember that withdrawing your tax-free cash immediately as a lump sum will mean it is in your estate for inheritance tax purposes, as well as potentially leaving your savings open to inflationary risk. As such, it is important to seek financial advice to help you understand whether this is the best strategy for you or not, as there are often better ways to harness the power of the pension freedoms landscape.

Shaun Moore, tax and financial planning expert at Quilter said:

“The cost of living squeeze is already being felt by most, and pensioners are among the worst off. Unfortunately, the situation is likely to get worse before it gets better, and more people are likely to need to dip into their savings to get by. While tax allowances are set to become increasingly less favourable over time, there are still ways to squeeze every last ounce out of those available to you to help you through this tricky period and beyond.

“When it comes to retirement income, well planned use of allowances can allow you to stretch your hard-earned savings that much further. If you have used a diverse set of investment products and average sized savings pots, you can now stand to tap into more than £50,000 of your savings per year utilising the available tax allowances for 2022/23.

“Each of the different products enable you to take home a rather small amount of tax free ‘income’ per annum, but when combined you find yourself with a substantial amount.

“However, tax efficient withdrawals should not be the only driver when choosing what products to use. For people who expect to pass on wealth when they die, there are other tax planning considerations to take into account. To make the most of the inheritance tax rules, people should consider first withdrawing from their investments which form part of their taxable estate, such as their ISAs. They should then consider withdrawing from investments which are outside of their taxable estate, such as pensions. Each product also offers different levels of flexibility and your particular financial circumstance will dictate what mix of investments is best. Where possible, you should seek professional financial advice to help ensure you make the best possible choices for you.”

[1] The rising cost of living and its impact on individuals in Great Britain - Office for National Statistics (ons.gov.uk)

[2] Impact of increased cost of living on adults across Great Britain - Office for National Statistics (ons.gov.uk)

[3] Starting rate limit for savings income is available for up to £5,000 of savings income for those with income under £17,570.

[4] The tax treatment and efficiency of these options will depend on the individual circumstances of each customer. Tax rules and their application may change in the future.

[5] Commentary for Annual savings statistics: June 2021 - GOV.UK (www.gov.uk)

[6] Retirement income market data 2020/21 | FCA