A bit about Teresa
Teresa is 60.
She has a defined contribution (DC) pension pot (based on contributions and investments) of around £100,000.
She also has a defined benefit (DB) pension (promising a set level of pension based on salary and how long she built up benefits) paying around £1,800 a year.
Teresa doesn’t need to rely on her pensions for income as her husband’s workplace and State Pensions pay around £53,000 a year, giving them a comfortable standard of living.
Teresa would like to use her pension pot for around £500 a month to spend on luxuries, without having to rely on her husband. She won’t get her State Pension for six years but it’s expected to be around £10,000 a year, so she won’t need the income from her pension pot when it starts.
Our financial planner points out that once Teresa starts to receive her State Pension, her flexible income plus her DB pension means she’ll be using up most of her income tax personal allowance. So, most of her £500 flexible income would become taxable.
Instead, our financial planner suggests she should take £25,000 as tax-free cash and invest it in an ISA so it stays tax free. She should do this during March and April to spread it over two tax years, as the ISA limit (in 2022) is £20,000 a year.
She can then take £10,700 a year from her remaining pension pot. Together with her DB pension this comes to £12,500 a year – so it’s all tax-free, as she isn’t going over her personal allowance (£12,570 in 2022-23). This is an income of nearly £900 a month, considerably more than the £500 a month she wanted. She can invest any money she doesn’t need in her ISA for future tax-free income.
After six years, she would have used up most of her pension pot but could claim her State Pension. It might be worth her delaying claiming her State Pension to use up her pot fully, as it could be taxed if it’s left to her beneficiaries. She might also get a higher State Pension by delaying.
This is a real-life example, but the name and details have been changed.