Should I take retirement income from my pension pots or Isas?

Q. I am 66 years of age, have recently retired and am looking at the most tax-efficient way of sustaining my lifestyle. I have just applied for the state pension. I live in a mortgage-free property and have another with a mortgage that I am renting out. I have various pension pots, adding up to about £100,000 and Isas that total about the same amount. My question is about the best way to access my savings. Should I be drawing down my 25 per cent tax-free lump sum from the pension pots and, if so, is it best to put that money into Isas, or leave my pensions where they are and draw money from the Isas to live on?Ian, London
Defined contribution (DC) pensions are schemes that leave you with a pot of money that you can access from age 55 (rising to age 57 in 2028), with up to 25 per cent of withdrawals tax-free and the rest taxed as income. These differ from defined benefit pensions (also known as final salary schemes) where there is no “pot’ as such, but you are guaranteed a set income in retirement, often set at a proportion of your salary.
All contributions to pensions benefit from tax relief at your income tax rate. Basic-rate tax relief is added automatically, so that £80 contributed to a pension is topped up by £20. Once your money is in a pension, it can grow completely tax-free. The maximum most people can contribute to a defined contribution pension each year and still benefit from tax relief is £60,000, including the tax relief and any employer contributions. You cannot contribute more than you earn.
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Isas do not come with an upfront tax relief boost but they do offer similar tax-free investment growth. Isas are, however, more flexible than pensions and can be accessed completely tax-free whenever you need them. You can pay up to £20,000 a year into Isas.
Turning now to your question: there is no obvious tax advantage to taking out your tax-free pension cash and putting the money straight in an Isa. This chunk of your pension can be accessed in exactly the same way as an Isa (ie tax-free) and most investment platforms offer exactly the same investment choice on both pensions and Isas. If this is not the case for some or all of your pensions, you could consider combining them and holding them with a single, low-cost platform. If you are thinking about doing this, make sure to check that you won’t be hit with any hefty exit charges or lose valuable guarantees on any of your pension plans.
There has been an increase in people taking their tax-free cash ahead of the budget on October 30. Some of this activity is likely to be driven by a fear that the chancellor could reduce or even abolish the entitlement. As a general rule, it is best to deal with the tax rules as you find them rather than reacting to rumour and speculation.
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There are also potentially negative inheritance tax (IHT) consequences to taking your tax-free pension cash early and investing it in an Isa. Pensions do not normally count as part of your estate for inheritance tax purposes, and if you die before age 75 your beneficiaries can also draw on them free of income tax, whereas any money held in Isas will count towards your estate for IHT purposes.
This will, of course, only be an issue if you think that you will use up your available IHT allowances. In 2024–25, the main tax-free IHT allowance is £325,000 per person, with an additional £175,000 if you leave your main home to a direct descendant, including children and grandchildren (note that if you leave your main home to your spouse or civil partner there is no IHT to pay).
If IHT is a consideration, the generous tax treatment of pensions means it often, slightly counterintuitively, makes sense to access these assets last in retirement.
Tom Selby is the director of public policy at AJ Bell and has campaigned for retirement reforms such as banning pensions cold-calling and increasing pension allowances