Choosing how to take your income in retirement is one of the biggest decisions you’ll make when planning for life ahead.
If you’re approaching retirement, you’re probably thinking about how to convert your pension fund into an income that will last you for the rest of your life.
You now have more options than ever, but with that comes the challenge of making the right decision for you. So how do you navigate the maze of choices?
What are your options?
If you have built up some defined benefit (DB) pension entitlement – often called final salary pension – this will give you a guaranteed income based on how much you were earning and how long you were a member of the scheme. DB schemes normally have an age at which the pension will be paid and are increasingly rare, with few employers now offering them .
Most people currently saving for retirement through their employer’s pension will be paying into a defined contribution (DC) pension, which offers no guarantees but does give you more options on how and when you retire.
Under new rules that came into effect in 2015, you can access your DC pension from age 55 – although this is due to rise to 57 in 2028 alongside a rise in the State Pension age to 67 . You can take up to 25% of your DC pension pot as a tax-free lump sum and then choose how to make withdrawals from the rest of your pension pot.
Any money you take out from your pension other than the 25% tax-free lump sum will be subject to income tax.
The main options are:
An annuity is a contract with an insurer that gives you a guaranteed income in exchange for some or all of your pension pot.
Many different types of annuity exist to suit different needs, such as rising in line with inflation, continuing to pay out to a spouse in the event of the annuity holder’s death, or offering a higher level of income based on health and lifestyle factors such as smoking.
Annuity rates have been low for several years . This is due in part to the low returns available on government and corporate bonds, which are used to partially fund annuities, as well as increasing life expectancy, which makes annuities more expensive to provide.
Although many people do not think annuities are attractive at the moment, they are still an option worth considering if a guaranteed income is important to you
Income drawdown allows savers to draw an income from their pension while keeping the remaining pot invested. While savers can benefit from market returns, they may also lose money when conditions are bad.
Drawdown allows you to take money from your pension pot flexibly, which raises the risk of either taking out an amount that will put you in to a higher tax bracket, or depleting your funds, unless you have a strategy in place to make it last.
If you have an investment drawdown product, there will usually be additional investment and fund management costs to consider.
Uncrystallised Fund Pension Lump Sun
Uncrystallised Fund Pension Lump Sun (UFPLS) is a typically difficult piece of pensions industry jargon that describes taking money out of a pension without converting the fund into a drawdown product or buying an annuity.
With UFPLS, you can take money out of your pension if the contract with your provider allows it, in a flexible manner. For every £1 you take out of your pension pot, 25p will be treated as part of your tax-free lump sum with the remaining 75p subject to income tax .
How can I get help making the right decision?
Before you decide how to take an income from your retirement savings, you should consider when you want to retire and the kind of lifestyle you’d like to lead. For example, retiring at or close to 55 and leading an active, adventurous lifestyle would require more money than retiring at close to 70 and leading a quiet life of reading on the sofa.
As your funds would need to last for potentially decades, you need to consider whether you have enough to live on and the risks of running out of money in retirement. It’s important to have a strategy that will make the most of the assets you have , such as pensions, savings, ISAs and investments.
Everyone’s situation is different and no single approach will suit everyone. Taking financial advice can help you understand what your options are and how likely it is that you might meet your goals for retirement. A financial adviser will be able to review your pensions and investments and offer you tailored recommendations.
To find out more about how financial advice could benefit you, contact us.
Important information: Our recommendations are likely to include stock market-linked investments. These are not like building society savings accounts as your capital is at risk and you may get back less than you invested. The value of your investments and any income from them may fall as well as rise.
Retiresavvy is brought to you by Skipton Building Society. This article has been commissioned by retiresavvy and any opinions voiced are the author's own.