Pension options at retirement shouldn’t be complex. Yet when you are near your selected retirement age, somewhere on this planet a tree is felled, bashed about and made into paper, which is then duly pushed through your letterbox as a “countdown to retirement” package. And then when you start to read the documents, which follow profession-prescribed formats, your pension options become as clear as mud.
It should be easy, right? You save into a private pension and at retirement, you get an income and a tax-free lump sum to enjoy. So why is it so different in reality? The purpose of this blog is to explain and simplify the pension options available to you for when the time comes.
Due to recent changes in the way you can access your pension, you are now faced with six main pension options at retirement. If your current pension company doesn’t offer all of these themselves, don’t worry because you can always consider switching. So, here are your basic options:
- Do nothing.
Just because you said you wanted to retire at age 60 doesn’t mean you have to take your benefits then. You may not need the money; you may still be working, or you may be living off other savings. That said, it may still be an ideal time to assess the suitability of the pension company, as you may wish to take this opportunity to amend your investment strategy or select a more flexible product. As such, when you do eventually access your pension, all options will be available.
Example: Mike set up a pension at 45 with the intention of retiring at 60. At age 60, Mike was enjoying his work and planned to keep going until he was at least 70. His adviser reviewed his pension and together they opted to push back the selected retirement date to 70. There were no penalties for deferring and, if Mike changed his mind and wanted to retire before 70, he would likewise not be penalised.
- Take it all in one go.
If your pension pot is relatively small, you can take it. 25% is tax-free and 75% is subject to income tax. If your pension pot is large, you can still take it in one go but you may find the taxation on the 75% unpleasant.
Example: Sue, a basic rate taxpayer reached age 65 and received a letter saying she had an £8,000 pension pot that she had forgotten about. Due to the small nature of the pot, Sue decided to take it all in one go. She took her tax-free cash of £2,000 and the remaining £6,000 was taxed to income at 20%. All in all, she received £6,800.
- Take your tax-free cash only.
You don’t have to take all of it; you can take chunks of it until you have exhausted 25% of the fund.
Example: imagine that Kate is 58, works and pays higher-rate tax. She has a personal pension worth £500,000 which means her current tax-free cash amount is 25%, or £125,000. Kate wants to buy a new car which costs £25,000. She decided to just take £25,000 as tax-free cash. Her remaining pension is valued at £475,000 and her remaining tax-free cash is £100,000.
- Buy a guaranteed income using an annuity purchased by an insurance company.
Search around for the best deal; you don’t have to use your current pension provider.
Example: Chris has decided to retire and access his workplace pension. He needs a secure income for himself and his wife for the rest of their lives. He decided to take his tax-free cash and, with the remaining pension, buy an annuity using the Open Market Option to secure the best deal. He has selected an income that rises each year by 3% to protect him from inflation and, in the event of his early death, his wife would receive a 50% widow’s pension.
- Go for a flexible income, known as flexi-access drawdown.
Example: Hardeep is a self-employed contractor aged 62, and business is a little challenging. He is just about to end a contract and he doesn’t have a new one to replace it. He previously accessed his tax-free cash aged 60 to clear his mortgage but he needs income until his next contract gets signed. He decides to take a taxable monthly income from his drawdown pension, knowing he can stop the income when it isn’t required.
- A combination of points 1 to 5.
You don’t need to select any one of these at retirement; you can combine. That’s the beauty of flexibility.
Sarah, 65, has an £800,000 pension she has yet to crystallise. £200,000 of this is available as tax-free cash. Next year she is due her state pension worth £9,000 a year, and she has a teacher’s pension that is paying her £6,000 a year. She wants to retire next year and needs a withdrawal strategy.
She needs £1,500 per month to meet the bills, so she can’t really take any risk with that. She knows her bills will only rise with inflation so needs that to be protected.
She has other discretionary spendings of £1,500 a month but she has an ISA that will cover this for the next 10 years.
She has £13,000 on a credit card and needs to spend about £50,000 on her house.
She has promised herself a six-month holiday to see her brother in California so needs £20,000 for that.
Reviewing her needs and options available, what would you do if you were Sarah? “Option 6. a combination,” I hear you say… Well done; you’re right! Here is what she did…
Sarah takes £83,000 of her tax-free cash to clear her credit card, see her brother in California and tidy up her house (option 3 exercised).
Sarah’s regular expenditure is £3,000 a month, or £36,000 a year. Of this sum, £18,000 comprises fixed costs that she has no discretion over. She has a £6,000 teacher’s pension and a state pension of £9,000.
Sarah buys a secure annuity income of £3,000 a year, spending £100,000 of her pension fund but giving her peace of mind. She knows her bills are now covered with £18,000 of secure income (option 4 exercised).
As Sarah has an ISA to cover the rest of her spending for the next 10 years, the rest of the pension is currently not needed, so this is left to grow for her future. A great outcome (option 1 exercised).
There is no denying it: accessing your pension can be complex and you can be faced with a range of options and potential pitfalls. To best avoid this, start planning now and seek advice. Your adviser will help you picture what a great retirement looks like and can build a strategy to help you achieve your dream life.
Let your adviser do the hard work, so you can sit back and get what you deserve: money in retirement to enjoy.