What options do you have at retirement?
Accessing pensions before retirement remains a popular option, with more than 1.3 million savers taking flexible payments from their pensions since the introduction of the pension freedoms in 2015.
While the premise of withdrawing 25% of your pension pot tax-free is not new, the options you have when you reach age 55 have increased.
Before the pension freedoms came into force in 2015/16, it was possible to withdraw a quarter of your pension pot tax-free and the choice then was simple: buy an annuity or a drawdown product.
Now, retirement savers have multiple of choices, with several options proving popular for accessing pensions before retirement. If you are considering taking money out of your pension pot, there are several considerations to take into account, but first of all you need to know what type of pension you have.
Pensions usually fall into two different types: occupational or private schemes. Private pensions, such as a Stakeholder Pension, Personal Pension or Self-Invested Personal Pension (SIPP), are money purchase schemes.
Occupational pension schemes are further divided into Defined Contribution (DC) and Defined Benefit (DB) schemes – but pension freedoms only apply to DC pensions.
With DB pensions, which are also known as final salary pensions, what you receive depends on your earnings rather than being dependent on investment performance and growth. These schemes are set up by your employer and provide you with a percentage of your salary at retirement. This calculation will be based upon the scheme rules.
While DB pensions do not qualify for pension freedoms, it is possible to convert them into a money purchase arrangement. However, this could be a high-risk strategy as you will be giving up valuable guarantees.
Pension freedoms do not apply to your state pension.
Options at 55
Leave it untouched
Continuing to save into your pension until the time comes to retire is the default position for most retirement savers in the United Kingdom.
You can contribute up to £40,000 of your annual earnings towards your pension pot in 2019/20 without paying tax, subject to taper rules which may apply to high earners and which reduce the annual allowance. This cap remains in place for 2019/20 at the time of writing.
The first time you take taxable income from your pension benefits, you then become subject to the £4,000 money purchase annual allowance instead of the full annual allowance, and your ability to make pension contributions and claim tax relief is much reduced.
Doing nothing is usually the best option unless you need the money for something in particular, whether that is to pay off your mortgage or help your grown-up children get on to the property ladder.
One former pensions minister once expressed fears that savers would withdraw all of their pension pot and spend it on supercars when the freedoms came in. If you did take this extreme step, the first 25% of your retirement savings would be free from tax whilst the remaining 75% would be taxed at your marginal rate of income tax.
This is still the case in 2019/20 but be aware that doing so could place you into a higher income tax band which would result in you paying 40% as a higher-rate taxpayer or 45% as an additional-rate taxpayer. This may be a suitable option if you have no major overheads and already have enough capital saved in other ways to maintain the same quality of life you enjoy at the moment.
Take several lump sums
Another option is to take 25% of your pension pot tax-free and leave the other 75% where it is, continuing to grow as an investment in your existing pensions. For example, imagine you have a pension pot of £200,000, you could withdraw £50,000 without paying tax, and leave the rest (£150,000) in your various pensions.
Whether you pay income tax on taking several lump sums depends on your total annual income in any financial year and the personal allowance.
You could withdraw up to £12,500 from your pension pot in 2019/20 without paying income tax on your withdrawals, providing that you have received no other income in the tax year. Any amount exceeding this threshold will be taxed at your marginal rate of income tax. This may be useful if you want to stagger your withdrawals over a period of time, such as the point at which you wish to retire.
Lump sum and drawdown
You could opt to take 25% tax-free after reaching the age of 55 and use the rest to buy a flexible income drawdown product. This would buy investments such as shares, corporate bonds, gilts, funds and more, giving you an investment portfolio which you can dip in and out of.
As this is an investment, you should be aware the value of your product can rise and fall at any time and you should accept the element of risk involved. Check in regularly with your adviser to see if it is performing as you wish. In the meantime, any income supplied through drawdown is usually paid out on a monthly basis.
The income you take from drawdown will be taxed at your marginal rate of income tax if you exceed the personal allowance.
Lump sum and an annuity
You can withdraw 25% of your pension pot without paying tax and purchase an annuity with the rest.
An annuity usually pays you a fixed annual income up until you die, but they have fallen out of favour with retirement savers in recent years. Annuity rates have offered poor returns since the pension freedoms were introduced, and due to low rates of inflation which affect the rates of income you receive.
However, data from Moneyfacts showed average income earned from annuities in the six months to June 2018 rose between 1.4% and 4.8%. Annuity rates have continued to improve since hitting all-time lows after the Brexit vote in 2016, with the average annual income in the first half of 2018 just 1.2% behind when freedoms were brought in.
If the idea of having a fixed annual income for the rest of your life appeals to you, be sure to research the best annuity rates. Higher annuity rates may be available dependent on medical and/or lifestyle factors.
Mix and match
It is possible to utilise multiple pension options, as an example you may opt to use some of your pension pot to buy a flexible income drawdown product and some to purchase an annuity. Various other combinations are available but be sure to seek professional advice before doing so as this option is the most complex.
Seek help with your decision
When the time comes to retire, what you do with your pension savings is one of the most important decisions you will make as it will affect the rest of your life. The Government offers free guidance for over-50s through its Pension Wise initiative, which was introduced after the pension freedoms were brought in.
However, the guidance merely outlines your options in a similar way to this brief guide and you should speak to a professional financial planner for specialist advice which is suitable for your situation. Professional advice is compulsory if you want to transfer defined benefit or safeguarded benefits worth £30,000 or more.
The way in which tax charges (or tax relief, as appropriate) are applied depends on individual circumstances and may be subject to future change. Pension eligibility depends on individual circumstances and you cannot usually take pension benefits until age 55.
This is solely for informational purposes and nothing in it is intended to constitute advice or a recommendation. You should not make any investment decisions based on this content. The value of pensions can fall as well as rise and you may not get back the amount you originally invested.
While considerable care has been taken to ensure this information is accurate and up-to-date, no warranty is given as to its accuracy