Early retirement is a dream for many. But the key to enjoying a long and happy second act of life is to structure your finances in the smartest way possible. It could be easier than you think - and the earlier you start planning the better.
Multiple sources of income
We’ve all heard the phrase ‘don’t put all your eggs in one basket’, and this is genuinely true for retirement savings. One way to pay for your lifestyle in retirement - and to live that life as early as possible - is to ensure you have income from multiple sources.
You might have some income from long-term savings such as investments, property income or ISAs. Then, there’s pension savings including any private or workplace pensions you have. If you’re eligible for the State Pension, you can also factor that in. Although you won’t be able to access it till you’re 66 (rising to 67 from 2028). Other sources could include any ongoing earnings if you aren’t ready to give up work completely, or you shift into a new type of work.
Having a portfolio of different assets can help you pay for your lifestyle for the next 20, 30 or more years. You’ll need to carefully consider how you can switch incomes from each source at just the right time depending on how and when you can access them.
Spend tax-free ISA income first
Using up tax-free ISA income first is a good idea in those initial 10 years of early retirement when you’re likely to be most active. Often called the ‘golden decade’, this might be when your spending is higher as you indulge in new hobbies, trips and experiences.
Enjoying your golden decade entirely tax-free is a real possibility for people who plan their finances well. For example, by investing the full £20,000 (2024/25) ISA allowance each year for tax-free income later on. When you come to spending this money it’s worth speaking to a qualified Independent Financial Adviser (IFA). They can help you plan by using ‘cashflow modelling’, essentially calculating how long each income stream you have will last.
Tax treatment of buy-to-let properties
If you own property you let out for rental income, you should look at these buy-to-lets next. Rental income will be taxed at your marginal rate after your tax-free personal allowance of £12,570 (2024/25). But as you progress through retirement you may want to consider selling your buy-to-let properties to help fund your lifestyle. Importantly, this can also help avoid your family having to eventually pay Inheritance Tax (IHT) on them.
Buy-to-let properties are subject to capital gains tax (CGT) when you sell them. CGT is 18% for basic rate taxpayers, and 28% for higher rate and additional rate taxpayers. It’s worth bearing in mind that only the profit you make from the sale is subject to CGT. However, you do get a yearly capital gain tax-free allowance of £3,000 (2024/25). Married couples and civil partners who jointly share an asset can combine their allowances, making their total tax-free allowance £6,000 (2024/25). So if you have several properties, selling them gradually over time during your retirement will keep your CGT bill as low as possible, as well as avoiding IHT.
Pension tax-free lump sum from age 55
For most pensions, once you reach the age of 55 (rising to 57 in 2028), up to 25% can be taken tax-free. But you don’t have to take it as early as that, or even all in one go. Thinking carefully about your tax-free pension lump sum can make it last longer.
For example, if you take your tax-free cash and leave it in your current account, over the long-term its value could be eroded away by inflation. But if you keep the money in your pension for longer, it has more opportunity to grow tax-free.
Someone with a £100,000 pension who needs £5,000 of tax-free cash, for example, rather than taking their entire 25% (£25,000) entitlement, could just take 5% (£5,000) of the tax-free cash they need. The remaining £80,000 of their pension pot could continue to grow tax-free over time. Leaving it invested also means it’s shielded from IHT - should they pass away - as the money in your pension doesn’t form part of your estate.
Last but not least - the State Pension and remaining private pension
You might be eligible to begin receiving the State Pension from 66 (rising to 67 from 2028). For the full new State Pension that’s up to another £11,502 a year or £221.20 a week (2024/25) you could add to your retirement income. Use PensionBee’s calculator to check your State Pension age and gov.uk to check your eligibility.
Now, onto any remaining private or personal pensions. Accessing these last could be a good idea if you can, because withdrawals after the initial 25% are taxed. Additionally, leaving your pension invested also means your beneficiaries usually won’t pay IHT. They’ll also not pay income tax on it if you pass away before you’re 75. Beneficiaries will have to pay their normal income tax rate if you’re 75 or over when you pass away. However the government announced in the Autumn Budget that the rules around IHT and pensions will be changing from 2027, so it’s worth keeping an eye out for further announcements as to how this will play out.
Finally, waiting until you’re further into retirement before you draw down the taxable income from your pension means you’re more likely to be able to keep your income below the £12,570 tax-free personal allowance (2024/25).
Summary
While you may be keen on the idea to retire early and finally get your hands on your pension, planning ahead is key. It’s important to keep up to date with the rules around pension saving and withdrawing as they can change. The new Labour government recently announced the rules around IHT and pensions will be changing from 2027, so it’s worth keeping an eye out for further announcements as to how this will play out. Consider making a financial plan ahead of time, understand where your sources of income are coming from and regularly check what the rules and tax implications are. Speak to an IFA if you aren’t sure - you can use the Financial Conduct Authority’s register to find one. They can help you understand what to access first and what will keep your personal tax bill as low as possible, while also saving your loved ones from a big IHT bill.
Laura Miller is a freelance financial journalist.
Risk warning
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.
