Which pot do you spend first?

Two people retire at 60 with the same money: a £350,000 pension, £80,000 in ISAs, £30,000 in cash. Both want £26,000 a year to live on. One pays several thousand pounds a year in income tax. The other pays nothing at all, for seven years running.

Nothing separates them except the order they take the money out.

This is the least glamorous decision in retirement planning and one of the most valuable. It doesn't require better investments, more risk, or any clever product. It requires knowing which pot to reach into first, and — more importantly — which allowances quietly expire every 5 April whether you use them or not.

The four pots, and what happens on the way out

Everything you'll draw from falls into one of four categories, each taxed completely differently when you spend it.

Your pension. 25% comes out tax-free, capped at £268,275 across all your pensions by the Lump Sum Allowance. The other 75% is taxable as income at 20%, 40% or 45% depending on what else you've got coming in that year. Crucially, it's the only pot that can soak up your Personal Allowance.

Cash savings. The capital is yours already, so withdrawing it isn't a taxable event at all. Only the interest is taxable, and the Personal Savings Allowance — £1,000 for basic-rate taxpayers, £500 for higher-rate — shelters most of it for most people.

General investment account. No tax on the capital you put in, but selling triggers capital gains tax on the growth. The annual exempt amount is £3,000, and above that you're at 18% or 24%. Dividends along the way are taxed separately, with only a £500 allowance.

ISAs. Nothing. No income tax, no capital gains tax, nothing to declare. The most flexible pound you own.

Look at that list and one thing stands out: three of the four pots come out at 0% tax for most retirees most of the time. Only the pension has a meaningful tax cost attached — which is exactly why so many people leave it until last, and exactly why that instinct costs them money.

The old rule, and why it has flipped

For a decade, the standard approach ran: spend your ISAs and investments first, leave the pension untouched as long as possible. The logic was sound at the time. Pensions sat outside your estate for inheritance tax, grew free of tax inside, and could pass to your children — free of tax entirely if you died before 75. The pension was the last thing you wanted to spend and the best thing you could leave behind.

From 6 April 2027, unused pension funds are due to come inside the estate for inheritance tax. For anyone whose estate exceeds the nil-rate bands, the pension stops being the ideal legacy asset and starts looking like one of the worst things to die holding — potentially caught by inheritance tax and then leaving beneficiaries with income tax on withdrawals.

So the old sequencing logic doesn't just weaken. It inverts. Drawing pension income earlier — to spend, or to gift away as regular expenditure out of income — moves from tax mistake to tax strategy for a great many families.

The principle underneath it all

Strip away the products and one idea does most of the work:

Every tax year, you get a slice of income at 0%. If you don't use it, it's gone forever.

The Personal Allowance is £12,570. It doesn't roll forward. It doesn't accumulate. A retiree living entirely off ISA withdrawals is declaring nil income and discarding £12,570 of tax-free capacity every single year — while a pension sits there, growing, waiting to be taxed at 20% or more later.

The same applies to the £3,000 capital gains exemption and the Personal Savings Allowance. Every year you don't use them, they vanish.

That's the whole game. The withdrawal order exists to make sure no 0% band goes unused.

The working order

Which gives you a default sequence:

1. Pension first — but only up to the top of your Personal Allowance. Take enough taxable pension income to use the allowance and no more. This money comes out at 0%.
2. Cash next. Capital withdrawals aren't taxable, and cash earns least, so it's the cheapest pot to run down.
3. The general investment account, harvesting gains up to the £3,000 exemption. Realise gains deliberately each year rather than accidentally in one large lump later.
4. ISA last. It's your most flexible, most tax-free pound. Use it to top up to the income you actually need, once the free allowances elsewhere are exhausted.

This is the order the Retirement Readiness Calculator models, and it's a sensible default for most people. But it's a default, not a rule.

What it looks like in practice

Back to the two retirees, both wanting £26,000 a year at age 60.

Drawing from the ISA first, she takes £26,000 out of the ISA. Tax paid: nil. It feels efficient. But her Personal Allowance goes completely unused — £12,570 of tax-free income capacity, discarded — and her pension keeps growing towards a bill she will meet later.

Drawing pension first, he takes an uncrystallised funds pension lump sum of £16,760. A quarter of that, £4,190, is tax-free cash. The remaining £12,570 is taxable income, which lands exactly inside his Personal Allowance and is therefore taxed at 0%. The whole £16,760 arrives tax-free. He then tops up with £9,240 from the ISA to reach the same £26,000.

Identical spending. Identical tax bill — nil, both ways. But he has moved £16,760 out of the pension at a 0% rate and preserved £16,760 more of his ISA.

Now stretch it to State Pension age at 67. Over those seven years he extracts around £117,000 from the pension having paid no income tax on any of it, while she has drained her ISA and left the pension intact.

Why the gap years matter so much

The window between finishing work and your State Pension starting is the most tax-efficient period of most people's lives, and it's easy to sleep through it.

Once the State Pension arrives — £12,547.60 a year at the full new rate in 2026/27 — it consumes almost the entire Personal Allowance on its own. From that point, virtually every further pound of pension income is taxed at 20% from the first pound.

Those gap years are a genuinely limited-time offer. Every year of it spent living off ISA money is a year of 0% income capacity thrown away, and it never comes back.

Where the default breaks

Follow the sequence blindly and you'll walk into at least one of these.

The Money Purchase Annual Allowance. Take taxable income from a defined contribution pension — via an uncrystallised funds pension lump sum, or from flexi-access drawdown — and your future contribution allowance for money purchase pensions collapses from £60,000 to £10,000, permanently. If you're still working, still contributing, or might return to work, this is the trap. The way around it's to designate funds into drawdown and take only the tax-free cash, which doesn't trigger it. Small pots of under £10,000 can also be taken in full without triggering it, up to three of them.

Still earning. If you're phasing into retirement with employment income, your Personal Allowance is already spoken for. Pension withdrawals stack on top of salary at your marginal rate, and if the combined figure crosses £100,000 you're into the band where the allowance tapers away and the effective rate reaches 60%.

Two people, two allowances. For couples, the sequence runs across both sets of allowances, not one. If one partner has a large pension and the other has almost none, filling the smaller pension's Personal Allowance first is usually the cheapest income in the household. Marriage Allowance may also be claimable where one of you is a non-taxpayer.

The capital gains uplift on death. Assets held at death have their base cost reset to market value, wiping the accumulated gain entirely. So there's an argument for not harvesting large gains you'd be content to pass on — spend cash and pension instead, and let those gains ride. This pulls against the inheritance tax logic above, and where an estate faces both issues the sums genuinely need doing rather than guessing.

Care and contingency. An order optimised purely for tax can leave you with everything in the least accessible wrapper. Keep enough in cash and ISAs to handle a bad year, a new roof, or the early stages of a care need, without being forced to sell investments at the wrong moment.

Means-tested support. At the lower end, drawing pension income can affect entitlement to Pension Credit and the benefits attached to it. Money left in an uncrystallised pension is treated differently from money you've taken out and put in the bank.

The one that catches almost everyone

Your first flexible pension withdrawal is nearly always taxed wrongly.

Providers have to apply an emergency month-1 tax code, which treats a single payment as though you'll receive the same amount every month for the rest of the year. Take £16,760 as a one-off and the system briefly assumes you're on around £200,000 a year and taxes it accordingly.

You get it back — either automatically at the end of the tax year, or sooner by claiming with HMRC form P55, P53Z or P50Z depending on your circumstances. But it's an unpleasant surprise if nobody warned you, and it's worth planning the timing of that first withdrawal with the reclaim in mind. Some people take a nominal amount first, purely to get the tax code corrected before the real withdrawal follows.

What to actually do

Work out the income you need. Work out how much of your Personal Allowance is already used by State Pension, defined benefit pensions or earnings. Fill whatever is left with taxable pension income, and no more. Then top up from cash, then the general investment account within the capital gains exemption, then the ISA. Do it again next year, because the allowances reset and the numbers move.

And if you're in the years between finishing work and the State Pension starting: that window is one of the most valuable tax planning opportunities you'll ever have, and it closes on its own.

This article is for general education only and isn't personal advice. Figures are based on 2026/27 rules for England, Wales and Northern Ireland, and tax treatment depends on individual circumstances. Withdrawal decisions are difficult to reverse — model them properly, or get them checked, before you act.

Try it with your own numbers

Retirement Readiness Calculator

Related in this series

• Turning pensions into income: the five decisions
• Working out what you actually need
• How much can you take without running out?
• What happens to what's left
• Tax year-end planning