A multi-asset approach to retirement income
Introduction
This briefing looks at how a multi asset approach using accumulated investments, including pension funds, can support a more tax efficient income in retirement, helping to preserve savings for longer.
Core considerations
- Holding a range of savings and investments across different tax wrappers and where possible held across spouses or civil partners can help in using all the available tax allowances and provide a more tax efficient and sustainable approach to income generation.
- From April 2027 pensions will no longer be exempt from IHT, the current IHT advantage of drawing from other assets before pensions will be cease.
- Pensions can be used in several ways – by using tax free cash and drawdown or a combination of both.
- Investment strategy is key – with assets matched to short term income needs and longer term growth.
Contents
The right investment strategy
This will be vital in meeting the income needs set by clients. This may be achieved through a blended approach to investment or through specific portfolios – for example short-term, medium-term, and long-term funds.
It is also worth considering holding retirement income in both guaranteed returns such as an annuity or scheme pension, and assets that are flexible such as flexi-access drawdown (FAD) or an ISA. This can enable clients to receive all, or the majority of their essential income from guaranteed returns, so that there is less risk of having to draw from flexible funds during poor market conditions, which can result in ‘pound cost ravaging’.
Pound cost ravaging
Increasing withdrawals, or in some cases continuing to draw the same level of income during periods of market downturn can result in a portfolio that depletes faster than planned. This is a particular risk with flexi-access drawdown arrangements.
For example, if 9% of withdrawals are being taken from a £100,000 fund (i.e., £9,000) then if the value of that fund drops to £90,000 before the withdrawal, this equates to a 10% withdrawal which will reduce the assets available to £81,000. There are then fewer assets to help the investment recover in the future. If a 9% withdrawal was to be maintained the amount drawn would need to reduce to £8,100. Drawing less could be mitigated by holding an amount in cash to cover short term withdrawals to avoid drawing on longer-term investments during market downturns. However, that cash will need to be replenished and replenishment would need to wait until the markets recover for this strategy to be successful.
In this situation even if the market recovers the client would still be left with a fund that has been depleted more than planned.
A well-diversified portfolio can help to reduce the risk of poor returns depleting a portfolio by smoothing market shocks. Clients that rely on smaller withdrawals are less at risk of pound cost ravaging, or they could choose to only withdraw the income and maintain their capital.
Example – Frank and Anna
Frank is married to Anna; they are both 66 years old and in good health and about to retire. They have no debts, a property valued at £775,000 and they have accumulated several investments over the years. They have been careful to invest across different tax wrappers with a diversified portfolio and split equally between themselves, each holding:
| £20,000 | cash on deposit |
| £20,000 | cash ISAs |
| £115,000 | stocks and shares ISAs |
| £20,000 | growth OEICs generating 2.5% per annum in dividend income |
| £350,000 | onshore investment bond – initial investment £250,000 |
| £300,000 | personal pension |
They want flexibility to change their income levels now and in the future - for example if they become less active in their later retirement years. They also want to ensure that if either or both die their spouse or heirs can benefit from their retirement savings.
They want joint income after tax of around £30,000 per annum in addition to their State Pension. The Office of National Statistics suggests that Frank’s life expectancy is to age 85 and Anna’s to age 88 but there is a 1 in 4 chance that either will survive into their 90s and beyond. Based on average mortality, their savings and investments need to provide them with income for more than 20 years.
The income from each of their savings and investments will be taxed as follows:
| Interest from cash on deposit @ 3% | = | £600 within 0% savings rate |
| ISAs | = | no tax to pay |
| OEICs 2.5% on £20,000 | = | £500 within 0% dividend tax rate |
| Bond | = | up to 5% per annum accumulative withdrawals (based on initial investment) tax deferred |
| Pensions | = | up to 25% tax free, remainder taxed as income |
Frank and Anna want to retain the interest paid from their cash on deposit.
Frank and Anna’s immediate thought is to draw from their pension funds to provide them with the income they need. They have no immediate requirement to generate a lump sum, so it makes sense to use that tax-free element to support their income needs in a tax efficient way.
If Anna and Frank do this, they will each need to generate £15,000 income each year in addition to their State Pension. They both qualify for a full new state pension which will provide £12,548 (2026/2027) per annum. With the personal allowance frozen; as the state pension increases this means less personal allowance is available for other income – almost all of the personal allowance is now used by the state pension.
Their income needs could be achieved by drawing down around £17,650 each from their pension funds. They could each take an uncrystallised funds pension lump sum (UFPLS) or could take tax-free cash and convert funds to drawdown, then immediately withdraw from drawdown. Both options would trigger the money purchase annual allowance and have the same tax and income outcome, but the UFPLS option is a simpler solution.
Anna and Frank’s position would be as follows:
| Income source | Tax status | Anna annual income net | Frank annual income net | Joint income net |
|---|---|---|---|---|
|
UFPLS: £4,412.50 (25% of £17,650) is tax free |
Zero tax | £4,412.50 | £4,412.50 | £8,825 |
|
UFPLS: £13,237.50 (75% of £17,650) is subject to income tax |
£22 within personal allowance – no tax £13,215.50 taxed at basic rate |
£10,594.40 | £10,594.40 | £21,188.80 |
| Total income | £30,013.80 |
Using this approach Anna and Frank do generate the income they need but will pay income tax totalling £5,286 (£2,643 each). They will also be drawing on pension funds that currently (until April 2027) could be passed on to their children free of Inheritance Tax.
The benefit of Anna and Frank’s diversified approach to investment means that it is likely (based on current tax rates and allowances) that they can generate the income they need without creating any immediate tax liability.
Instead Anna and Frank could take:
- 4% withdrawals from their bonds which generates tax deferred income (with no immediate tax to pay) of £10,000 each. This level of withdrawal may begin to erode into the capital value but should still provide them with a degree of security in relation to their longevity and/or inflation-proofing.
- The £500 income generated from each of their OEICs provides them with an additional amount of income which is also free of tax as it is within their dividend allowance. This is natural income so will not be eating into their invested capital within the OEIC.
- £3,500 could be drawn each year from their stocks and shares ISAs (around 3%) which should be sustainable as well as being free of tax.
- Frank and Anna's State Pension of £12,548 only leaves £22 of their personal allowance, which means pension income such as UFPLS will generate an income tax liability which they are trying to avoid. They could however, each take PCLS of £1,000 and convert £3,000 to drawdown – without drawing income. This way they continue to generate the tax-free income they require.
Anna and Frank’s position can therefore be summarised as follows:
| Income source | Tax status | Anna annual income | Frank annual income | Total income |
|---|---|---|---|---|
| OEIC | Within dividend allowance – zero tax |
£500 | £500 | £1,000 |
| Bond | Within 5% withdrawals – zero immediate tax |
£10,000 | £10,000 | £20,000 |
| Stocks and Shares ISA | Zero tax | £3,500 | £3,500 | £7,000 |
| Pension | PCLS – zero tax | £1,000 | £1,000 | £2,000 |
| Total income | £30,000 |
Alternatively, Frank and Anna could take UFPLS instead of PCLS, incurring some income tax now as part of a longer-term solution - retaining a larger uncrystallised fund to generate more future tax-free cash.
As a result of taking their income from across their savings and investment pots, Frank and Anna will save combined income tax of £5,286 each year rather than only drawing from the pension. They also have opportunity to draw a further 1% (£2,500) each from their bonds and it still be tax deferred (this doesn’t account for any accumulated 5% annual withdrawals they have not yet accessed). They can both draw more on their ISAs tax-free, and they also have significant pension funds that can continue to provide tax-free cash, which can be drawn gradually at this level for many years. If their income needs increase, they may have no choice but to draw some taxable income.
If their income needs continue to be sustainable and they draw at a rate that roughly equals the fund growth, they should consider their estate planning and what actions can be taken to mitigate their expected IHT liabilities.
From April 2027, pensions will be included within the scope of Inheritance Tax (IHT), meaning that the traditional advantage of leaving pension funds untouched for IHT efficiency will no longer apply. Historically, drawing on assets subject to IHT—such as ISAs, OEICs, and bonds—early in retirement could help reduce the overall IHT liability on second death. However, with pensions becoming assessable, this strategy may require significant reconsideration.
For individuals whose combined estate (including the value of their pensions) exceeds £2,000,000, the residence nil rate band will taper away, making comprehensive IHT planning essential going forward. This would be important for Frank and Anna to consider as on second death their total assets could exceed £2,000,000.