Retirement Withdrawal Strategies – Part 1

I’ve been thinking about this one for a while, trying to find a way to make it simple and straightforward. There’s already some great work out there on withdrawal strategies, including from GoCurryCracker and the Mad Fientist/JL Collins, but they’re specific to Americans in the US. You could work out a similarly simple approach for non-Americans in the UK. But when you combine the two systems and the broad range of accounts, it just gets complicated.

The aim of this series is to keep it as simple as possible, and to cover two things:

  • When can you get your money so you can retire (part 1)
  • A basic approach to minimizing taxes during withdrawal (part 2)
  • Putting it all together – tax management in the phases of retirement (part 3)
  • Some illustrative scenarios (part 4)

I’m not going to cover asset allocation, rebalancing, safe withdrawal rates, inflation, or capital gain/loss harvesting – these are all important, but let’s keep it as simple as possible for the moment.

I’m also going to mostly ignore the cash portion of your portfolio. Not because it’s unimportant – it’s critical to funding your day to day needs. Just because it’s a) already easily accessible and b) not going to generate a ton of taxable income. Even if you have 5% of a £1,000,000 portfolio in cash (£50,000), at today’s interest rates you’re maybe getting £500 a year at 1% interest. If you’re already managing your taxes, an additional £500 of income isn’t going to move the needle.

For the examples, I’ll mostly use a married couple where both are US taxpayers and are staying in the UK for retirement – this is the hardest case, in many ways. If you’re a single US taxpayer, all the same ideas apply, just with most of the US limits cut in half. If you’re a couple where only one person pays US tax, you have some advantages (try to keep stuff that is taxed by the US but not by the UK in the name of only the non-US taxpayer).

All numbers are for 2021 – this stuff changes every year, mostly going up with inflation although bigger changes are possible, depending on what Congress or Parliament decide to do. Some of the ages change over time too – I’ve used the ones that apply to somebody in their mid-30s, but if you’re somewhat older, a few will be earlier.

Where is your money?

If you’ve followed the flowchart, you likely have a variety of accounts, probably in both the US and UK, and with a variety of tax treatments. Something like this:

Edited 07May21, to move UK pension/SIPP to US Tax Deferred with an updated footnote. I think this its fair to present a reasonably conservative interpretation as baseline, and I’m less convinced of the US tax free nature than I once was.

Quick reminder on those three different tax treatments, focusing on how you get your money out (not tax advantages when you contribute to them):

  • Tax Free: When you take money out of these accounts, there are no taxes, including on any gains on top of what you put in originally
  • Tax Deferred: You don’t pay taxes on gains as they happen, but when you take money out, it is taxable as income (not capital gains – even though some of the value will be gains on the invested capital).
    • Both the US and UK have mostly higher tax rates for income than capital gains. For the US, they need to be long term capital gains, held over a year.
  • Taxable: Gains are taxable as they arise – if you sell something that has appreciated, that’s subject to capital gains tax. If you get interest or dividends, that’s subject to tax.
    • The US taxes interest at income rates, and dividends are at either income or capital gains rate depending if they’re ordinary or qualified. If you’re doing buy and hold investing, most of your dividends will typically be qualified.
    • The UK also taxes interest at income rates. Dividends are taxed at a rate in between income and capital gains.

When can you get your money?

Except for non-Lifetime ISAs and taxable brokerage accounts (aka general investment accounts), there are restrictions on when you can get your money. There are also exceptions to many of these rules – we’ll ignore those here, because they tend to apply in cases of hardship, first home purchases, or tragedy. The one we won’t ignore is the Traditional to Roth conversion – I’ll include those in this plan, although will save the nitty gritty details for a future post.

Those ages are spread out from 55 to 70, with a bunch of option and nuance in between. At a very high level, here’s a timeline – the color-coding matches up to the tax treatment, although most wind up as that ugly yellow/green color that means they’ve got some kind of mixed treatment.

That’s kind of a mess, right? To me, it helps to break this up into three phases:

The boundaries aren’t perfect, but there are big conceptual differences between each of these. Let’s explore each one in a little more detail:

Phase 1: Early Retirement

This phase starts whenever you retire, or even partially retire and expect to start needing to withdraw funds from your savings.

This is a pretty simple phase – there aren’t all that many options to get to your money without paying penalties, and the order is pretty clear:

  1. Taxable accounts – you can get to these any time, but will need to be careful about realizing capital gains and the taxes you pay on those. If you can do any capital gain & loss harvesting before retirement, that can help.
  2. S&S ISA – the only investment account with both some tax advantages and full penalty-free withdrawals at any time. But, you need to keep an eye on the US tax consequences, same as a taxable account. And, once you’ve withdrawn the contributions, you can’t replace them – you’ve lost the future tax-advantaged growth forever.
  3. Roth contributions – these can also be withdrawn any time without penalty (not the gains! Keep good records). Barring Traditional to Roth conversions, this is probably a relatively low number just because the Roth IRA contribution limit is low (if you had a Roth 401(k) and contributed a lot to it, that could be different). You also can’t replace the contributions once they’re gone – you’ve lost the future US and UK tax-free growth on those contributions forever. So this is my last resort – it may make sense to use a little bit each year to keep your taxes out of higher brackets, but don’t go too heavy.
  4. Depending on how much you’re spending vs your available savings, you may have some headroom before you start paying too much tax. If so, there there’s an opportunity to convert Traditional to Roth (via an IRA, if your Traditional contributions are in a 401(k) or similar). This is a US taxable, UK tax free event (most likely), and needs some careful planning to make sure you don’t pay excessive tax on it. Once you do the conversion, you can get to the money after 5 years with no penalty.
    • I do plan a future post exploring this from the perspective of an American in the UK – for now, this great Mad Fientist explanation will get you started.
    • The very short answer to the UK implications is that Traditional to Roth conversions aren’t taxed in the UK.

Phase 2: Middle Retirement

Things start to get more complicated here, and the options get much more variable. This is where you get access to all your money, so assuming you have enough invested and no terrible sequence of returns happens, the challenge stops being making sure you don’t run out of money and starts really focusing on tax and estate planning. The key changes:

  • UK Pension/SIPP – withdrawing from this early can help if you’re in danger of exceeding the Lifetime Allowance, but it’s also the best account if you’re planning on leaving a significant inheritance, since it’s not included in your UK estate.
  • Traditional IRA, 401(k), etc. – withdrawing early, along with Roth conversions, can help manage Required Minimum Distributions
  • Roth gains – fully accessible without penalty or tax, a great place to get spending if you’ve already filled up your tax buckets (we’ll talk more about buckets in Part 2).
  • Lifetime ISA – once you hit 60, it’s basically the same as a S&S ISA – UK tax free, US taxable.
  • HSA – now available for uses other than health expenses, although taxable in both countries.

The mix in which you access these will depend a lot on your individual situation, we’ll look at it in more detail in Part 3.

Phase 3: Traditional Retirement

The key change here is that you start getting income again, beyond just withdrawals from accounts:

  • UK State Pension – probably from age 68, although you can delay it (or that age might get pushed out over time)
  • US Social Security – somewhere between age 62 and 70, your choice (the longer you wait, the more money you get, but the fewer years you’ll collect it before passing away)
  • Traditional IRA/401(k) Required Minimum Distributions – starts from age 72, and can be quite huge if you haven’t planned for them

You also get the final Lifetime Allowance test on your UK Pension/SIPP at age 75.

Conclusion & Next Steps

That was a bit of a whirlwind tour through the timing of when you can access various accounts, across the three phases of retirement. In Part 2, we’ll look at how you might be able to pay zero (or at least very little) taxes across your retirement!

13 thoughts on “Retirement Withdrawal Strategies – Part 1

  1. I am not convinced that the 25% tax-free lump sum pension withdrawal in the UK (from a UK pension) is also tax-free in the US (if you are resident in the UK) either via an actual lump sum or via UFPLS. Have you seen a convincing analysis of this in the treaty or know that it is IRS approved? Thanks.


    1. I’m also not convinced that a 25% lump sum is US tax free – I’ve seen arguments both ways, and it gets into very lawyerly territory, past my comfort zone, lots of debates around the definition of “lump sum” and whether or not what the UK pension laws call a lump sum is the same as what the treaty considers a lump sum, etc. All very confusing, and I can see why people can differ over whether a lump sum is any non-periodic chunk, or if a lump sum is only a 100% distribution.

      Before this morning, I was fairly convinced that, as long as pension/SIPP contributions are reported on US tax returns, pension/SIPP withdrawals will be US tax free. That’s Article 18 para 5c – contributions made to a UK pension scheme are treated by the IRS as if they were made to a generally corresponding pension scheme in the US. If US tax is “paid” on the contributions (although usually offset by the FTC), then the logical corresponding pension scheme in the US would be a Roth 401(k), with tax-free withdrawals. If it was treated as a Traditional 401(k), with the US assessing tax on the withdrawals, that’d remove all tax benefit, which would go against what I think the treaty is saying. But doing more research this morning and looking at a few of David Treitel’s comments, I’m now questioning that interpretation – maybe it’s actually treated by the US still as a Traditional 401(k) but with a stepped up basis (contributions would be tax free, but gains would be taxed as income). I will caveat this in the post, at least.

      If pension/SIPP contributions weren’t included on US tax returns, I’m also confused – there’s an argument that the 25% tax free portion might apply to periodic payments, but it’s a little bit roundabout, not certain it’d hold up. Pretty certain that the other 75% would be US taxable, I don’t see a logical argument otherwise. But since it’s UK taxable as well, at the higher UK rates, you probably won’t wind up paying US tax anyway. Depending on the exact situation and how big the withdrawals need to be, it really might not make any difference if the US taxes 75% or 100% – between the Standard Deduction and FTCs, there might not be any or only minimal US tax owed.


      1. I’ve always used the FEIC on my UK earned income, including employee/personal pension contributions. I used to forget to include employer pension contributions (not that there were very many), but I assume if I’m using the treaty that these are also not currently taxable. David T seems to prefer using FTCs right from the beginning, but that’s no longer an option for me, and I’m not about to start treating part of the pension in one way and part in another. I agree with your final assessment about the lump sum. I certainly don’t plan to take 25% all in one go, but instead use UFPLS and so will almost certainly still pay higher tax in the UK. I actually just closed a small SIPP for my dad in 2020 and took the 25% all in one go, but since he was already bumping into higher rate UK tax, the FTCs easily cleared his US tax. Fingers crossed that is, he still hasn’t got his IRS refund… Note that his IRA provider does not allow him to set his RMD withholding level to 0%. It says the IRS sets the minimum withholding for a foreign resident to 10%. So he’ll always have to ask for a refund…


      2. Fully agree on not treating parts of the pension separately. I’ve used FTCs from the beginning, but once had an idea of electing the treaty benefits in some years and not in others. That’s far too complicated – I’m sticking with not claiming the treaty benefits to exclude my and employer contributions, reporting both as taxable income. It’s still US tax free during accumulation, I don’t build up quite so many FTCs that I’ll struggle to use, and it can only help in withdrawal (whether it’s treated by the US as a Roth or as a Traditional but with a built up gain and maybe/maybe not 25% tax free withdrawals I’m not sure of anymore, but it helps no matter what).

        Realistically, my UK pension will probably be the last account I touch – unless there’s a bad sequence of returns, I may never touch it at all (or maybe just a couple years, bridging from age 55/57 to 59.5) and pass it on as is. Just have to keep an eye on the lifetime allowance.


      3. I’m digging more into withdrawals from UK pensions – what’s your reasoning behind planning on UFPLS instead of drawdown? Obviously not putting the entire amount into drawdown and triggering US tax from the UK tax-free lump sum, but using small drawdowns? Want to make sure I’m not missing anything.

        Simple example: you want to withdraw £20,400k from your pension. Let’s say it’s all taxed at the basic rate, because other income fills your personal allowance. Let’s assume UK pensions are fully US taxable, for the sake of argument, and US tax rate is 12%.

        UFPLS Option: Withdraw £24,000. £6,000 is tax free, £18,000 is taxed at 20%, resulting in £14,400 after tax of £3,600. Effective tax rate is 15%, above US tax of 10 or 12% – no US tax due to FTCs.

        Drawdown Option: Designate £24,000 for drawdown. Take £6,000 tax-free as pension commencement lump sum. £18,000 is taxed at 20%, resulting in £14,400 after tax of £3,600. Effective tax rate is still 15%, still no US tax.

        Additional Drawdown Option: Designate £28,000 for drawdown. Take £7,000 tax-free as PCLS. Take additional £16,750 taxable at 20%, resulting in £13,400 after tax of £3,350. Effective tax rate is now 12%, still no US tax and no “wasted” FTCs to carry over. £4,250 remains crystallized in the drawdown account (will be UK & US taxable on withdrawal). UK tax slightly reduced for today.

        I’m not sure that last option is actually all that useful, but I am curious if there’s an advantage to UFPLS that I’m missing – otherwise the first and second options are identical, just using different terminology.

        Appreciate any thoughts you have – the UK pension withdrawal landscape is rather complicated!


      4. Good question. I haven’t looked that closely at the comparison between partial drawdown and UFPLS, because I’ve not had to do it yet. However, there is an interesting section in Andy Bell’s book (of AJ Bell) “The DIY Investor” where he says he is unconvinced that UFPLS (introduced with the 2015 pension freedoms) is all that significant compared to drawdown. Let me quote: “Which option is best for you will depend on whether it is more important to you to keep as much in the SIPP as you can – so partial drawdown may be best – or whether you want to retain as much of your tax-free lump sum as you can for future use – in which case you may prefer UFPLS. Taking an UFPLS will restrict the amount you can pay into your SIPP in the future, as you have flexibly accessed your pension. If instead you took the whole amount as a tax-free lump sump under partial drawdown, your ability to contribute wouldn’t be affected. For those in a pension already offering drawdown, which would include all SIPPs, the UFPLS isn’t really that significant an introduction. Pretty much the same can be achieved by taking a tax-free lump sum payment from some of your pension and withdrawing all of the funds that had been moved into drawdown in one go. One thing to be aware of is that, if you choose this option, you’re likely to receive the tax-free and taxable payments a few days apart. With the UFPLS you’ll receive a single payment.”

        In his two case studies, he is comparing someone who takes a disproportionately large chunk of tax-free cash with someone using UFPLS withdrawals. I don’t care about the lowered annual contribution limit of UFPLS and I want to spread the tax-free element out for the full life of the SIPP, so UFPLS sounds fine to me and perhaps simpler than crystallizing the pension in specific chunks every year. I might be convinced to use partial drawdown if the charges were cheaper, but my sipp is with AJ Bell, so the charges are the same (zero).

        Also, generally my thinking goes that unless I need a load of money up front, I want to leave the tax-free element invested for as long as possible, especially if I’m still invested quite aggressively and the funds will still be growing. The £ value of tax-free cash in the future might therefore be larger (adjusted for inflation) than taking more at the start. I see what you’re saying about trying to harvest FTCs as efficiently as possible (although you could just use carry forward instead), but it seems overly complicated to my simple mind 🙂


      5. Thanks for replying – agree, that option 3 was just something that occurred to me, but seems like a lot of faff for not much real benefit.

        Sounds like, when we’re looking at maybe quarterly or annual withdrawals from the SIPP, there isn’t really much difference. We want to avoid excessive tax-free amounts (or we’ll pay US tax on them), so will keep all withdrawals not too far from the 25/75 default of UFPLS, even if using drawdown. It may just come down to which is easier to do in the particular website of your SIPP provider, UFPLS or drawdown.


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