How to achieve a £31,600 tax-free retirement income (2024)

Retirees have been given the freedom to choose how they spend their pension savings, after years of having to buy an annuity.

But the income and investment choices now on offer can be bewildering, and poor decisions in the early days can have catastrophic consequences later on.

The perfect pension plan will be different for everyone – it depends on various factors such as how much you have in savings, your other assets and whether you want to pass wealth on to your family.

In general though, it’s a good idea to secure a guaranteed income that will cover all of your essential costs such as housing and bills first and, if you want to keep some money invested, use the savings you have left over. Keep a close eye on tax planning too – making full use of your allowances could take you out of the tax net altogether.

Based on our postbag and inbox of questions from readers we have put together a typical scenario of a couple in their sixties who are about to retire.

‘We want £36,000 a year’

Peter and his wife Louisa, our hypothetical couple, are planning for his retirement. They would like an income of at least £1,500 a month – or £18,000 a year – to meet their basic needs, but would prefer £3,000 a month.

Peter, a management consultant, earns £75,000 a year. He has been winding down his business and expects to retire next year at 65. His wife is 63 and has already retired. She has just started to receive her state pension of £5,200 a year and also receives a teacher’s pension of £4,100 a year.

Peter expects his state pension to be £6,000 a year, as he was “contracted out” of the system for a while. He also has a private pension pot of £200,000.

Both Peter and Louisa have built up savings and investments outside their pensions, worth £232,000 and £220,000 respectively. Peter has a stocks and shares Isa worth £145,000 and a cash Isa worth £12,000. He has £7,000 in a Santander 123 current account and £5,000 in a Nationwide e‑saver account. He also owns various shares worth £60,000 and £3,000 of premium bonds.

Louisa has £85,000 in a stocks and shares Isa and £45,000 in a cash Isa. She has £30,000 in her Santander 123 current account and £50,000 in her Nationwide e‑saver. In addition she has £10,000 worth of shares.

They are both happy to accept stock market risk and describe themselves as experienced investors.

The couple live mortgage-free in their £450,000 cottage in Northamptonshire. Both are in good health. Financial security is their primary goal, but they would also like to maximise the legacies for their three children and five grandchildren.

Here, Danny Cox of Hargreaves Lansdown, which provides financial advice, sets out a precise pension plan for how they could achieve their financial goals.

The pension plan

Peter and Louisa will have an annual guaranteed index-linked income of £15,300 from next year. This is made up of their state pensions (£6,000 plus £5,200) and Louisa’s £4,100 teacher’s pension.

All of this income will be tax free because it will fall within their personal allowances for income tax.

The couple need to secure only another £2,700 a year in guaranteed income to meet their basic needs (£18,000).

When Peter retires, he should take his 25pc tax-free lump sum, which from a £200,000 pension pot will be worth £50,000.

He should then use some of the money left in his pension to buy an index-linked annuity, with a 50pc spouse’s pension if he dies first. This would pay him £2,700 a year and is likely to cost around £80,000. Louisa would receive £1,350 a year if Peter were to die first.

The remaining £70,000 should be put into a “flexible drawdown” plan, which would generate an additional income of £2,500 a year. The table above shows the funds that Mr Cox recommended for this plan.

Tax-free cash

As neither of the pair has used their £15,240 Isa allowance for this year, Peter should invest £30,480 of his £50,000 tax-free cash split equally across their stocks and shares Isas. This would bring their combined investment Isa values to £260,480.

The £19,520 balance should be put into their savings accounts.

Stocks and shares

Peter and Louisa should invest their stocks and shares Isa portfolios predominantly in “equity income” funds – professionally run portfolios invested in shares that pay good dividends – for an income starting at £9,600 a year, a figure that should rise over the coming years. For a detailed breakdown of Mr Cox’s recommended funds, see the second pie chart above.

Peter and Louisa’s share portfolio, held outside their Isas, should provide an additional income of around £1,500 a year.

Cash

The couple have £171,520 in cash savings, of which £57,000 is already in Isas. They should use the remaining £114,520 to fund their Isa contributions in future years.

In the meantime, some of Louisa’s cash savings should be moved into Peter’s name from April 2016 to maximise their use of the new £1,000 “personal savings allowance”.

From the start of the next tax year, basic-rate taxpayers will be able to earn up to £1,000 interest from bank accounts tax-free, while higher-rate taxpayers will be able to earn up to £500. This allowance is in addition to tax-free returns on cash Isas.

Total income

By following this plan, Peter and Louisa will have a tax-free retirement income of £31,600 a year, or £2,633 a month, from April 2016.

This consists of £18,000 worth of guaranteed, index-linked income to cover their basic needs, with £2,500 of variable income from drawdown, which should be sustainable and should rise over time. An additional £11,100 a year of variable income is from their stocks and shares Isas and other shares. This too should be sustainable and should rise over time.

Their combined personal allowance, personal savings allowance and dividend allowance (£5,000 a year each), plus their use of Isas, will mean the couple should pay no income tax.

The total is a little short of Peter and Louisa’s ideal monthly income of £3,000, but they have plenty of cash savings to spend if they want to.

“The foundations of this financial plan are to meet all their basic income needs with guaranteed, inflation-proof income,” Mr Cox said.

“Regardless of what happens in the markets, to interest rates or to inflation, Peter and Louisa will always be able to pay their bills.

“It will be important for them to apportion their assets between them to maximise tax-free allowances and to continue to use their Isa allowance to minimise the tax they pay.”

Planning your own retirement income: 'We developed our own software to work it out'

The pension freedoms that came into force in April have seen demand soar for financial advice about how to handle retirement savings. But sitting down with a financial adviser, and paying the associated fees, is just one way to devise a sensible plan. A number of online tools have been launched to allow savers to map out their own financial future, based on their assets and income requirements.

When Richard and Naomi Collinson struggled to determine how long their money would last them in retirement, they developed their own software tool to help.

The site, RetireEasy.co.uk, is free of charge and allows you to input your assets and liabilities, as well as forecasts for variables such as inflation, average returns and house price growth. It then predicts how far your money will stretch. The aim is that you don’t spend too much in retirement, or curb your spending unnecessarily. Users can factor in specialist assets such as yachts, fine art and classic cars and can continually revise their plan as their circ*mstances and forecasts change.

Many of the major pension providers and investment companies, including Standard Life, Aviva and Fidelity, offer retirement income tools, as well as programs that will work out your estimated life expectancy to give you an idea of how long your money will need to last.