What Retirement Money Should You Spend First?

On the way up your wealth mountain it’s easier to know where to save your retirement money.  

Most people will understand the basics of Pensions and ISAs and if you are able to make the most of these allowances every year and invest wisely, you should be in a good position at the top of the mountain when you reach retirement age.  

But what about on the way down? Which pot should you be taking your retirement money from first?  

Spending your retirement money in the right order can make a big difference in the amount of money you can spend and how long your money will last.  

Retirement money doesn’t just mean pensions

When I first meet with new clients who have reached retirement age, they are usually planning to start taking an income from their defined contribution pension. After all, pensions are made for retirement right? 

Quite often I will find they also have large amounts of cash savings, including cash ISAs and Premium Bonds. They see these accounts as their safety net, for use in emergencies only.  

Then there are investment ISAs as well and maybe even some investments outside of ISAs. 

So overall a collection of different pots. 

Whilst pensions are likely to be one of the biggest assets you own, when it comes to retirement it doesn’t mean you should withdraw all of your retirement money from them.  

Using a pension first in retirement causes a number of problems: 

• Apart from 25% of the pension pot being tax free, the rest is subject to Income Tax so you might have to withdraw more from your pension to get the ‘net’ amount you need.  
• You’re not making use of other allowances from other investment pots that will reduce your tax bill. 
• Taking money from your pension which is hopefully invested and leaving lots of cash ‘untouched’ means you are lowering your overall portfolio risk level. Cash is unlikely to keep up with inflation meaning it is losing money in real terms each year.  
• You might be selling investments inside your pension during a decline in the stock market.

Let’s look at an example of a 63 year old who has just retired. They have the following accounts to provide their retirement money: 

• £100,000 in a bank account. 
• £100,000 in a cash ISA. 
• £200,000 in a Stocks and Shares ISA invested in a balanced portfolio. 
• £380,000 in a defined contribution pension invested in a balanced portfolio. 

If this person was to take all their annual retirement money from their pension first until it ran out and then used their investment ISA followed by their cash ISA and lastly cash in the bank, their maximum sustainable spending in retirement would be £17,900 per year. 

This is what they could spend to ensure their portfolio lasts as long as their life and still works in the worst of stock market scenarios.  

However if they changed the order of their retirement money withdrawals so that they used cash first and then the investment ISA with the pension being last, their maximum sustainable spending would be £23,400 per year. A massive £5,500 a year better off! 

Retirement money from multiple sources

Now it’s not actually as simple as just re-ordering your retirement money pots as everyone’s circumstances are different, especially when it comes to using different tax allowances. However the basic principle applies, don’t hold too much cash and make sure you are investing appropriately to grow your income during retirement. 

Here’s how to plan what retirement money to use first: 

1. Don’t hold too much cash – You only want to hold enough cash to cover around 6 month’s spending and any large one-off spending you have coming up.  
2. Pensions and the personal allowance – You don’t have to wait until retirement age to withdraw money from your pension, you can do it any time from age 55 (changing to 57). If you have no other earnings you can withdraw your personal allowance (£12,570 currently) and not pay any Income Tax. You can then recycle this money into an investment ISA to keep it invested. ISAs are tax free. 
3. Use other allowances – By investing appropriately you might want to use the ‘natural income’ your portfolio produces. For example a general investment account outside of an ISA could produce dividends to use your annual dividend allowance and interest to use your annual savings allowance.  
4. Get your investment strategy right – A lot of people have a tendency to lower their risk level in retirement but actually this will lower growth over the long term meaning a lower level of income and more chance of your retirement money running out. It’s better to understand the impact of your investment strategy and assess the risk you can afford to take.  
5. Have ‘defensive’ pots – Every portfolio should be split into two, a growth bucket and a defensive bucket. The defensive bucket should have enough money in it to cover around 3 years of withdrawals. This means when we go through a period of market decline you don’t have to sell assets in your growth bucket, leaving them time to recover.

How are you going to stop yourself sliding down your wealth mountain in retirement? 

If you would like to structure your investment portfolio so it takes advantage of all the tax reliefs available and puts you in a position to know how much income you could produce for the rest of your life then please schedule a no obligation free 15-minute call.  

Risk warning:

Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.