Since Pension Freedoms were introduced in 2015 you have much more flexibility regarding how you can withdraw and spend your pension. From age 55, if you wanted to, you could spend the whole lot on a mid-life crisis sports car. We probably wouldn’t recommend it, but you can!
The problem with increased flexibility is that it also increases complexity. The changes have also enabled a shift in how we go about retiring.
Previously, many people followed a fairly similar path of working until their 65th birthday and using their pension to purchase an Annuity, providing a guaranteed income for life. However, retirement lifestyles have changed considerably in the last few decades. Pension Freedoms make it easier to match your pension spending with your desired lifestyle.
But, retirees are increasingly concerned about their money running out. With more responsibility placed in your hands, you need to ensure your pension income will last a lifetime.
Research from Aegon found 38% of financial advisers say running out of money is their clients’ primary concern as more retirees opt to access pensions flexibly over purchasing a guaranteed income.
With this in mind, it’s important to weigh up the pros and cons of each option, in relation to your personal retirement goals, before accessing your pension.
What are your options?
When accessing a pension fund that you’ve been paying into throughout your working life, there are three main options.
Purchase an Annuity
This used to be the most common way to access a Defined Contribution pension. It’s a policy that you purchase, which will then deliver a pre-defined income for the rest of your life. The level of income will depend on a range of factors, including your age and health.
There are many different Annuity providers to choose from, so shopping around for the best deal is important. There are also various Annuity products to consider. For example, some can be linked to inflation to maintain your spending power while others will continue to pay out to a named partner on your death.
The key benefit is that the income is guaranteed. You don’t have to worry about running out of money in your later years. However, this comes at the cost of inflexibility and you may find that the rate offered isn’t as attractive as forecast investment returns.
Withdraw lump sums
Should you choose to, you can withdraw your pension through a lump sum or multiple lump sums. Usually, only the first 25% of each withdrawal is tax-free meaning that this option may not be the most tax-efficient, as the remainder will be taxed as income.
However, there are times when a lump sum might be appropriate. For instance, taking a lump sum could mean paying off your mortgage, funding a once in a lifetime trip or completing a home renovation project. It’s an option that can help make your retirement dreams a reality.
As well as the tax implications, you should carefully consider how you’ll create an income. Do you have other pensions or assets that you could use? Taking a lump sum without a long-term plan could leave you financially vulnerable in the future.
Remember, you’re not obliged to access your pension at any point. Should you choose to, your pension can remain where it is. This can have some benefits if you’re concerned about Inheritance Tax, as money held within a pension is typically considered outside of your estate for this purpose.
Under this arrangement, your money will typically remain invested and you’re free to access the funds as and when you choose to.
The essential thing to keep in mind here is that your money is invested. As a result, the value of your savings can rise and fall. Investment returns can help your savings keep up with inflation and hopefully improve your retirement income. However, you also need to consider what you would do if investments performed poorly.
The advantage of using Flexi-Access Drawdown is that you can change the level of income throughout retirement. As more retirees continue to work in some form or plan large one-off expenses, this may be useful to you.
You’re also in control of your income. Of course, this comes with responsibility and can be viewed as a drawback as well as a benefit. You’ll need to ensure you’re withdrawing sustainable levels of income; there is a risk of spending too much, too soon.
What’s right for you?
There’s not a single solution for creating the perfect retirement income. It will depend on your personal situation, provisions, and priorities as you prepare to wind down your career.
The decisions you make around accessing your pension can affect your income for the rest of your life. Some decisions are irreversible, so it’s important to consider how your needs and goals may change over time.
This is an area where financial planning can help. Our goal is to help you find a financial solution that is appropriate for the retirement lifestyle you want to achieve.
Above, we’ve outlined the three main options open to you when accessing a Defined Contribution pension. However, you don’t have to exclusively choose one option, though you can if you prefer. Many retirees use a hybrid approach to create an income that suits them.
For instance, you may choose to purchase an Annuity to create a base income that’s reliable, accessing the remainder of your pension flexibly as and when it’s needed.
Need more advice? Email us at firstname.lastname@example.org or give us a call on (01785) 876222.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.