Once you stop earning a salary, your income has to come from somewhere else – usually a mix of pensions, savings and investments. Getting that mix right, and making it last, is one of the biggest financial decisions most people ever make, and sits at the heart of our Pension & Retirement Planning service. This guide walks through where retirement income can come from, the main strategies for generating it, and the tax allowances that affect how much of it you actually keep.
Where does retirement income come from?
Most people in retirement draw on a combination of these sources, rather than relying on just one:
- The State Pension – a guaranteed income from the government that rises each year under the “triple lock” (the full new State Pension is £241.30 a week, or £12,548 a year, in 2026/27). Not everyone will qualify for the full amount, as it depends on your National Insurance record. It’s payable from age 66, gradually rising to 67 for people born on or after 6 April 1960, phased in between 2026 and 2028.
- Defined benefit (“final salary”) pensions – a guaranteed income for life from a former employer, if you have one.
- Defined contribution pensions – a pot of money you’ve built up, which you need to actively turn into an income (through drawdown, an annuity, or a mix of both).
- ISAs, savings and other investments – flexible, and anything held in an ISA is tax-free, though savings and investments held outside an ISA may be taxable.
- Property – either downsizing, or releasing equity from your home.
The State Pension and any defined benefit pension usually form the reliable “floor” of your income. The real planning decisions are about how to draw the rest.
The three main ways to generate an income
1. Natural income
You invest for income – dividends from shares, interest from bonds, rental income from property funds – and live off what the investments pay out, leaving the underlying capital untouched. This can provide a stable, predictable income, but it can also mean holding a portfolio that’s less diversified than it should be, purely to chase yield.
2. Total return
You invest for the best overall balance of income and growth, then draw a sustainable amount each year regardless of whether it comes from income or from selling down a small amount of capital. This is now the more common approach among our Asset Management team, because it doesn’t force your investment strategy to bend around producing a specific yield.
3. Capital drawdown
You simply draw down capital directly, in a planned way, running the pot down over your expected retirement. This needs the most careful modelling, since the biggest risk is running out of money too early – particularly if a downturn happens early in retirement (known as “sequencing risk”).
Annuity or drawdown? The pension decision
If your retirement income includes a defined contribution pension, you’ll need to decide how to access it:
- An annuity converts your pot into a guaranteed income for life, in exchange for giving up control of the capital. Annuity rates move with interest rates and gilt yields, so it’s worth shopping around – rates can vary significantly between providers for the same pot.
- Flexi-access drawdown keeps your pension invested and lets you draw an income you control, with the flexibility to change it – but the value can still fall, and the pot can run out if withdrawals aren’t sustainable.
- Many retirement plans use both: an annuity (or your State Pension and any DB pension) to cover essential costs, with drawdown providing flexibility for discretionary spending.
The tax allowances that affect your retirement income (2026/27)
How much of your retirement income you keep depends on which allowances you use. For the current 2026/27 tax year:
- Personal Allowance: the first £12,570 of income is tax-free for most people.
- Personal Savings Allowance: £1,000 of interest is tax-free for basic rate taxpayers, £500 for higher rate, and none for additional rate.
- Dividend Allowance: the first £500 of dividend income is tax-free, regardless of tax band.
- Pension tax-free cash: usually up to 25% of your pension can be taken tax-free, capped at a Lump Sum Allowance of £268,275 across all your pensions.
- Capital Gains Tax annual exempt amount: £3,000 of gains outside an ISA are tax-free each year.
Using ISAs, pension tax-free cash and these annual allowances in the right order can make a meaningful difference to how much income reaches your pocket rather than HMRC’s, and is exactly the kind of detail our Tax Planning service is built around.
How much income do you actually need?
Most retirement income plans start by separating spending into essential costs (housing, bills, food) and discretionary spending (travel, hobbies, gifts). A common rule of thumb is a starting withdrawal rate of around 3–4% of your invested pot per year, adjusted for inflation – but the right number depends heavily on your circumstances, how your investments are positioned, and how much flexibility you have to reduce spending in a bad year. This is exactly the kind of calculation a cash-flow plan is built to answer properly, rather than applying a generic rule to your specific situation.
Frequently Asked Questions
How much can I take from my pension tax-free?
Usually up to 25% of your pension pot, subject to the Lump Sum Allowance of £268,275 across all your pensions combined. Anything beyond your tax-free entitlement is taxed as income when you draw it.
What’s a sustainable withdrawal rate in retirement?
There’s no single right answer – it depends on your pot size, how it’s invested, your life expectancy and your flexibility to adjust spending. A commonly cited starting point is 3–4% a year, reviewed regularly rather than fixed for life.
Do I pay tax on investment income in retirement?
Potentially, yes – interest, dividends and capital gains outside an ISA or pension wrapper can all be taxable, though each has its own annual tax-free allowance (see above).
Should I choose an annuity or drawdown?
Many people use a combination: an annuity (or guaranteed pensions) to cover essential costs, with drawdown for flexibility. The right split depends on your risk tolerance, health, and how much guaranteed income you already have.
Ready to Plan Your Retirement Income?
Turning savings and pensions into a retirement income that lasts is rarely a one-off decision – it’s a plan that needs to flex as markets, tax rules and your own circumstances change. If you’d like help building yours, speak with OCM today or explore our Pension & Retirement Planning service.
