ISA or pension first? The £167,000 retirement decision nobody explains.

You've spent thirty years being told to save into a pension. Nobody tells you what to do on the day you start taking it out - and that decision, made once and repeated for thirty years, is worth more than most of the investment choices that came before it.

The instinct that costs six figures

Ask someone with an ISA and a pension which they'll spend first and most say the ISA. It's the accessible one. It's already been taxed. Leaving the pension alone feels like leaving the good china in the cupboard.

The trouble is that a pension isn't china. It's a tax liability with a wrapper around it. Every pound in there - beyond your 25% tax-free entitlement - has to come out as taxable income eventually, and the only real question is what rate it comes out at. Leaving it alone doesn't avoid that. It just concentrates it into fewer, later, more expensive years.

The same person, three different orders

Take someone retiring at 60 with a £600,000 defined-contribution pension, a £200,000 ISA and £25,000 of cash. They want £45,000 a year to live on, rising with inflation at 2.5%. Their pots grow at 5% a year, less 0.5% of charges. Their State Pension starts at 67. They take their tax-free cash as 25% of each withdrawal. Nothing about the pots changes between the three runs below - only the order they're emptied in.

“The same pots, the same spending, the same market. £167,300 of difference, and four extra years of money, from a decision that costs nothing to make.”

Why the accessible-first instinct fails

Look at the first year. Under ISA first, our retiree takes £45,000 straight from the ISA and pays £0 in tax. It looks like a win. Under fill the basic-rate band, they take £49,984 gross from the pension instead, of which £37,488 is taxable, and pay £4,984.

Paying £4,984 rather than nothing looks like the worse deal, and for one year it is. But three things are happening in the background that only show up over a decade.

1. The personal allowance is use-it-or-lose-it. Every year you take no taxable income, £12,570 of tax-free income is thrown away. You can't carry it forward. Over the seven years before the State Pension starts, that's £87,990 of allowance that ISA-first simply never uses.
2. The pension keeps growing. At 5% a year, an untouched £600,000 pot is well over £800,000 by the time you're forced to face it - and all of that growth is taxable on the way out.
3. The State Pension arrives and takes your allowance. From 67, £12,547.60 of taxable income lands whether you want it or not, and it eats the personal allowance first. Every pension withdrawal after that is taxed starting from a higher rung.

By the time ISA-first has spent its accessible money, it has a very large pension, no allowance headroom, and a spending target that inflation has pushed up for a decade. It has to draw hard, at 40%, from exactly the pot it was trying to protect. The plan runs dry at 83.

You have to take out more than you want to spend

This is the bit that catches people. Pension withdrawals are taxed as income, so the amount you take is not the amount you get. At basic rate, £1,000 in your hand costs £1,250 out of the pot. At higher rate it's £1,667. The gap between those two numbers is the whole argument for controlling which band you're in.

That's what "fill the basic-rate band" means in practice. Each year you take pension income up to the point where the next pound would be taxed at 40% - £50,270 of total income in England, Wales and Northern Ireland - and anything you still need comes from the ISA, where it isn't taxable income at all. You never pay 40% if you can help it, and you never waste the 20% band either.

The quiet bonus: no National Insurance, ever

Pension income - drawdown, annuity, final salary, State Pension - attracts no National Insurance at any age. On £45,000, an employee pays around £2,594 of NI. A retiree on the same £45,000 pays none. It's the reason retirement income goes further than the equivalent salary did, and it's worth remembering when you're deciding how much you actually need.

On £45,000 of pension income, income tax alone comes to £6,486 in England, Wales and Northern Ireland, leaving £38,514. In Scotland the same income costs £6,882 - £396 more - because the 42% band starts at £43,662 rather than £50,270. Small on one year; not small across thirty.

Where this rule of thumb stops working

"Fill the basic-rate band" is a good default, not a law. It's the wrong answer in a few real situations, and it's worth knowing which ones apply to you.

• You have a small pension and a big ISA. If the pot will never breach the basic-rate band anyway, the sequencing barely matters and you should optimise for something else.
• You want to leave the pension to someone. Pensions have historically sat outside the estate for inheritance tax, and the rules are changing from 2027-28. If legacy matters, get advice rather than a rule of thumb.
• You're still contributing. Once you flexibly access a pension, the amount you can pay in drops to £10,000 a year. Starting drawdown early to use an allowance can cost you more than it saves.
• Your income is near £100,000. The personal allowance tapers away above it, producing a 60% effective rate in most of the UK and 67.5% in Scotland. Drawing into that band is almost always a mistake.

What to actually do

Work out, for each year between retiring and the State Pension starting, how much taxable income you can take before the next pound costs 40%. Take that much from the pension whether you need it or not - if you don't need the cash, it can go into an ISA. Top up whatever's left from savings. When the State Pension starts, recalculate: the headroom just shrank by about £12,500.

That's arithmetic, and it changes every year as inflation moves your spending and growth moves your pots. It's exactly the sort of thing worth having modelled rather than guessed.