Making decisions about your pension options as you approach retirement can be daunting.
It’s possible to cash in the whole lot, take a regular income or lump sums and keep investing the remainder in the stock market. You can also choose to swap the money for a guaranteed income via an annuity.
It’s important to consider managing the tax you pay and crucially, to make your money last as long as you need it, especially if you have worked long and hard to amass a good pension pot.
Here are the main pension options at 55 – and why you might want to consider them.
When it comes to assessing pension options, flexibility is the main attraction offered by income drawdown plans, which allow you to access your money while leaving it invested which means your funds can continue to grow. You have complete control over how much or little you wish to draw down.
You can choose to take the 25% tax-free lump sum upfront and leave the rest where it is, or to have a regular monthly income. Alternatively, you can simply withdraw ad hoc lump sums as and when you want to spend (remembering that withdrawing up to 25% of your pension whether that be as a lump sum or in smaller withdrawals is tax free - anything over this amount is subject to tax).
These flexible features can be used to your advantage when it comes to tax planning. For example, you can delay drawing down income if it would push you into a higher tax bracket during a given tax year.
Flexible schemes also allow for a change in circumstances as you can tweak the level and frequency of the payments whenever you need to. At the beginning you might need an income to, say, cover a mortgage. Once that is paid off, you might want to reduce the amount.
Finding the right drawdown provider means doing some detective work around your pension cost on charges and customer service. You don’t want your money with a company that can’t look after its customers.
Another important element of income drawdown is how to invest the remaining money in your pension. Choosing the right funds is the key to providing the combination of income and growth needed to maintain the capital you will be drawing on.
While you might want to reduce the risk of your portfolio when you retire to preserve your money and minimise ups and downs, remember that you might be retired for 20 or even 30 years, which is especially important for those considering pension options at 55, the earliest age at which a lump sum can be taken.
Cutting out all risk could mean you lose out on valuable growth. So it's really important to understand your investment options and what they mean for you.
Buying an annuity
Annuities, which enable you to exchange your pension pot for a guaranteed income for life, were once the most common pension option to fund retirement.
But recent changes to the pension freedom rules have given savers increased flexibility, meaning annuity sales have plummeted as retirees have taken more control.
Annuity rates, which dictate the income you get, have consistently fallen in recent years, which in turn has contributed to their fall in popularity. The reason is that the rates are linked to the interest rate on government bonds and central bank rates.
However, annuities still appeal to those who need a guaranteed income on top of the state pension. That secure, regular income throughout retirement – which is taxable – will bring peace of mind for some that bills can be paid on time.
Plus, if you smoke or have a health condition, you could be entitled to a much higher income via an enhanced annuity. These tend to pay more because annuity providers expect to pay out over a shorter time.
Among the most common conditions that people declare are diabetes, obesity, high blood pressure and high cholesterol.
Providers have reported that fixed-term annuities have recently become more popular as stock market volatility emerged as a growing concern for those looking for reliable income. These pay a guaranteed income for a specified term and some pay back a set amount at maturity.
They are ideal for those who are seeking a guaranteed income for a number of years but are reluctant to sign up for a lifetime annuity.
Shopping around for the best annuity rate remains critical for anyone approaching retirement.
Many people make the mistake of taking the one offered by their current pension provider. Different providers offer different rates so it's important to check your pension and shop around for the best deal on the market, not just the best rate from your own.
The hybrid option
Of all the pension options, the right move for many may be a mix of those mentioned above. You might want to use some of your savings to buy an annuity to cover the essentials (rent, mortgage or household bills) with the rest placed in an income drawdown scheme that allows you to decide how much you can afford to withdraw and when.
Alternatively, some might want more flexibility in the early years of retirement, and more security in the later years. For those people, this may be a good reason to delay buying an annuity until later in life.
The tax-free lump sum
This is an important consideration for those weighing up pension options at 55, the earliest age at which you can take up to 25% of your pension pot tax-free.
But it is worth asking yourself whether you really need the money now. If you can afford to leave it invested until you need it then it has the opportunity to grow further.
Leave it to grow and you can enjoy an even bigger tax-free amount in years to come. Remember, you don’t have to take it all at once – you can take it in several smaller amounts if you prefer.
When you receive your retirement pack from a pension provider or scheme, you don’t have to start drawing on it. You can delay payments until you want or need them to start.
With your private pension the benefits of delaying it include that your money remains invested for potential further growth and is sheltered from inheritance tax. Your entire pension savings are free of inheritance tax if you leave them untouched, provided that you die before age 75.
Before delaying your pension, make sure you check the terms of the pension scheme or provider whether changing the date is possible and ask what charges apply and if there are any deadlines for notifying them.
You can even delay your state pension. For every year you delay your entitlement will be increased by 5.8% for life – so the longer you live the more you stand to benefit.
Making the decision
Having saved long and hard to build a pension fund, you want to make the right choices on what to do with that money for the best.
Getting pension advice can be a crucial factor in this decision-making. If you are unsure about the type of pension scheme that is best for you, seek the help of a professional adviser who can guide you.
You might need to transfer your pensions to achieve the best outcome in retirement if one or more of your pension plans doesn’t offer fully flexible options.
Data by pensions company Profile Pensions shows that 94% of pensions reviewed don’t allow customers to flexibly access their cash from 55.(1)
Its analysis revealed that flexible drawdown could mean needing £56,000 less to retire comfortably(2) – and retiring six years earlier.(3) Having an adviser onside to explain the jargon, find the best drawdown or annuity provider can give you confidence in your retirement plan.
The Telegraph Pension Advice Service powered by Profile Pensions will provide 100% impartial advice on your pensions. It is free to sign up and Profile Pensions will review what you have and give you a personal recommendation if your pensions can be improved(4). Sign up online today.
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Capital at risk. This does not constitute personal advice. If you are in doubt about the suitability of an investment, please contact one of Profile Pensions’ advisers.
Prevailing tax rates and reliefs are dependent on your individual circumstances and are subject to change. Past performance is not a guide to future performance.
- Profile Pensions: 2,702 pensions reviewed between October 2019 and March 2020
- Figures quoted are for illustrative purposes only. Investment performance from flexible drawdown assumes an annual 3% average growth, although this is not guaranteed and the income from your pension may therefore go up or down. The example uses an annuity based on £9,051 level income a year based on a single life, non-smoking, 67-year-old in good health. Annuity quote was obtained in January 2020.
- Based on above example – needing £56,000 less with flexible drawdown and additional annual pension income of £9,051 needed in addition to a full state pension for a ‘comfortable’ retirement
- Free recommendation if pension can be improved, a one-off arrangement fee of between 1-3% of each pension policy will apply if you decide to act on the recommendation given and will be deducted directly from your pension upon transfer. - visit profilepensions.co.uk/cp/telegraph/main for details
Information correct at date of publication.