5 steps to help you create a tax-free income in retirement

Managing your tax exposure in retirement is as important, if not more so, as it is at any other time in your life.

Your retirement income may combine your pension, ISAs, cash savings, and other investments, alongside guaranteed income from your State Pension, a defined benefit (DB) pension, or an annuity.

How you use these different pots and the order you withdraw from them can make a significant difference to the amount of tax you pay. With careful planning, you may be able to combine different sources of income to meet your spending needs without paying Income Tax.

Read on to discover five steps that can help you achieve this.

1. Understand your Personal Allowance

The Personal Allowance is the amount of income most people can receive before paying Income Tax.

In 2026/27, the Personal Allowance for most people is £12,570. However, yours may be lower if your income exceeds £100,000.

The full State Pension is £12,547 a year (2026/27), meaning if you receive the full amount, you would have just £22 left of your Personal Allowance before you start paying tax on your income.

If you have other forms of guaranteed income, such as a DB pension or annuity, it’s important to factor these in as they could quickly take you above the Personal Allowance. In this instance, you may want to explore deferring your State Pension for a few years to keep your income down, but it’s important to speak to a financial planner before doing so.

2. Make use of your ISAs

You can withdraw money from an ISA without paying Income Tax on the amount you take out. Moreover, the interest or investment returns generated within an ISA are free from Income Tax and Capital Gains Tax.

This means you can use an ISA to supplement your income without increasing your tax bill.

For example, suppose you receive £12,548 a year from your State Pension and need £25,000 to cover your spending. You could take the remaining £12,452 from an ISA without creating any additional Income Tax liability.

This can make ISAs particularly valuable in retirement, even if you also have a substantial pension.

In 2026/27, you can contribute up to £20,000 across your ISAs. However, from April 2027, people aged under 65 will be limited to £12,000 Cash ISA contributions, with the remaining £8,000 of the allowance reserved for investment ISAs. Over-65s will be able to continue using their £20,000 allowance as they wish.

3. Use the tax-free portion of your pension wisely

You can usually take up to 25% of your pension as a tax-free lump sum, subject to the Lump Sum Allowance (LSA). For most people, the LSA is £268,275 in 2026/27.

The rest of your pension is typically taxable when you take it as income.

As such, it’s a good idea to carefully consider how and when you access your pension. Taking smaller amounts over time can allow you to combine the tax-free portion with other tax-efficient income sources to help create a sustainable income that lasts longer.

Moreover, leaving some of your pension invested gives it more time to grow throughout your retirement, which can help extend the longevity of your wealth.

4. Explore ways to combine different sources to give you a tax-free income

Often, the best way to ensure your retirement income remains tax-efficient is to blend different sources.

For example, let’s say you want £50,000 a year to fund your retirement lifestyle. One way of meeting this could be:

• £12,548 from your State Pension

• £22 from cash savings to bring you to the Personal Allowance

• £8,000 from your ISAs

• £29,430 from your available tax-free pension cash.

Under the current rules and limits, this example strategy could provide a £50,000 annual income free from Income Tax for over nine years, after which your pension would become taxable.

Of course, this isn’t a universal strategy. You would need sufficient pension and ISA savings, and the amount of tax-free pension cash available will depend on your circumstances and how much of your LSA you have already used.

5. Your tax-free income may change over time

It’s also important to remember that a tax-free retirement income isn’t necessarily something you can maintain indefinitely.

Your Personal Allowance is limited, and the tax-free portion of your pension is subject to your LSA. Your ISA withdrawals are tax-free, but the money in your ISAs can eventually run out.

This means your retirement income strategy may need to evolve, and it’s a good idea to factor in your lifestyle goals around that.

For example, many people find that their retirement falls into three broad categories, each of which comes with varying expenditure:

• Early years often involve high spending as you may travel, see family, and take up hobbies.

• Middle years may see your expenditure fall as you spend more time at home and become less active with age.

• Later years may require more money as you may need to pay for care.

A financial planner can use cashflow modelling to show how your lifestyle could affect your income and savings over the course of your retirement. They can then explore how to use your retirement fund to ensure it remains tax-efficient.

For example, this could mean drawing more on your ISAs and tax-free lump sum when your spending is likely to be higher, and saving more of your taxable sources for the quieter years.

With the right planning, you may be able to make better use of the tax allowances available to you and create a retirement income that meets your needs while keeping your Income Tax bill as low as possible.

To speak to a financial planner, get in touch.

Email info@mlpwealth.co.uk or call us on 020 8296 1799.

Please note

This article is for general information only and does not constitute advice. The information is aimed at individuals only.

All information is correct at the time of writing and is subject to change in the future.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.