Retirement is an exciting time; a culmination of years of hard work and planning. But if you’re due to retire this year, you’ve also got some important decisions to make.
Understanding the size of your fund, the options available to you and the amount of income you can expect to receive – not to mention the sustainability of that income – can all help you head into retirement feeling relaxed and confident.
Where is your income coming from?
First off, it’s important to remember that your income will probably not be made up entirely of the pension plans you hold.
Retirement income is more likely to come from multiple sources – a combination of your State Pension, private or workplace pensions, and any other assets you hold.
1. The State Pension
If you’re retiring this year you will be receiving the new State Pension (payable to men born on or after 6 April 1951 and women born on or after 6 April 1953). Until 5 April 2020 the full State Pension is £168.60 a week; from 6 April 2020, this rises by 3.9% to £175.20 per week.
If you have gaps in your National Insurance contribution history, you may not receive the full State Pension. Obtain a forecast if you want to know exactly how much your State Pension will be when you retire.
2. Defined Contribution schemes
You might have a Defined Contribution (DC), or Money Purchase pension. Contributions are paid into a pension ‘pot’ and the pot is then used to provide an income at retirement.
Since Pension Freedoms were introduced in 2015 your DC pension options have increased. As well as a regular income, you now have the option to take a one-off lump sum or take money out of your pot whilst leaving the rest invested, known as ‘drawdown’.
You’re usually entitled to a 25% tax-free cash lump sum too.
3. Defined Benefit schemes
A Defined Benefit (DB), or Final Salary scheme, is an occupational scheme offered by some employers.
A DB scheme pays a guaranteed regular income for life, but the income paid isn’t determined by the amount in your pot. Instead, a calculation is made, taking into account your ‘final salary’, the number of years you have been in the scheme and the ‘accrual rate.’
The accrual rate is the proportion of your earnings you’ll receive as a pension for each year in the scheme. This is most often 1/60th or 1/80th but you can check this with your pension provider.
It’s possible a tax-free lump sum may be available too.
4. Investments
You might have other investments that you intend to sell to part-fund your retirement. The value of these could impact on the retirement option you choose so having up-to-date valuations for these is crucial.
Check your latest statement or request a valuation so that these investments can be included in your calculations.
5. Other assets
Any other assets you hold should also be factored in. If you’re looking to downsize, for example, the money you make from the sale of your property should be included in your retirement calculations.
What’s the best option for you?
When encashing your pension plans you can receive your income in a number of different ways, and it’s important to choose the right option for you.
1. An annuity
An annuity will give you a regular income for life.
You will often be entitled to up to 25% tax-free cash as a one-off ‘pension commencement lump sum’ but once you commit to an annuity, it’s unlikely you can then make any changes.
You’ll need to specify at the outset your intended payment frequency and any ‘extras’, for example, a spouse’s pension paid in the event of your death or a pension that increases each year to combat the effects of inflation.
An annuity is inflexible, but it does give you peace of mind and a regular, known income, that can help to make budgeting simpler.
2. An Uncrystallised Fund Pension Lump Sum (UFPLS)
This option involves taking your whole DC pension pot as a lump sum. Normally, 25% of this will be tax-free, with the rest taxed as income at your marginal rate.
Some providers will allow you to take multiple UFPLS payments, each taxed the same way. If your provider doesn’t offer this it might be possible to transfer to one that does, most likely for a fee.
An UFPLS could be an option if you’re looking to use your retirement to travel for example, or to make home improvements, as it frees up a large amount of cash in one go. But a large one-off payment could push you into a higher tax bracket.
An UFPLS is also inflexible. Once your pension fund has been taken in this way, the responsibility for budgeting falls on you.
You need to be sure you’ll have enough to live on. And with the minimum retirement age currently 55, and average UK life expectancy closing in on 81, your money might have to last you another quarter of a century or more.
3. Flexi-access drawdown
With this option, you take up to 25% tax-free cash from your pension pot and then invest the rest to give you a regular income.
The difference between Flexi-access drawdown and a regular annuity is that you have control over the income you receive. You can alter the amount and the frequency, taking income when you need it.
This option, as the name suggests, gives you the greatest flexibility but can make budgeting harder as you need to keep track of the investment amount remaining. The value of your investment (and any income from them) can go down as well as up. Your capital is at risk.
Speak to an adviser
There are lots of available options. Whilst some offer flexibility and the chance to indulge, others have longevity but can tie you into a regular, unvarying income. The option you choose will depend on what you want from your retirement.
You have many options available to you at retirement and the tax implications of each can be complicated. An adviser can help structure your income in the way that suits your individual needs, whilst ensuring it’s also tax efficient.
If you’d like to discuss your retirement options, investment options or your current retirement plans, please get in touch. Please email info@investmentsense.co.uk or call 0115 933 8433.
Please note
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 by 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.
