What should I do with my pension at retirement?

Before you retire, it's a good idea to understand all of your pension options because this will probably be the primary source of your income during retirement.

Deciding what to do with your pension at retirement depends on several factors, including your aspirations, your financial situation, and, of course, the type of pension you have.

What are your main pension options?

At this stage in your life, you've likely built up one or more workplace or personal pensions, which you can typically access from the age of 55, although this is rising to 57 from 6 April 2028. 

Following the introduction of pension freedoms in 2015, several options are now available to access your pension.

• A tax-free lump sum, usually 25% of the fund. 
• An annuity.
• Flexible Drawdown
• Taxable lump sums 
• Taking a tax-free lump sum

 

Taking a tax-free lump sum

You can take up to 25 per cent of any pension pot tax-free up to a maximum of £258,275. The simplest and normal way to do this is in the form of a single lump sum.

This is sometimes an attractive option if you need larger sums to spend early on in your retirement, such as clearing a mortgage, travelling, or helping your children.

However, you need to plan carefully. You need to ask yourself how much you can afford to spend. You don't need to spend it at all, and it may be a good idea to reinvest some or even all of it as a flexible source of additional funds you can draw on when needed.

This can be especially helpful if you're using drawdown, as there may be times when it's wise to reduce your drawdown income temporarily.

Accessing the rest of your pension pot

If you have taken your TFC, any extra money you take from your pensions will be taxed as ordinary income, and there are a range of options available.

• Purchase an annuity (a guaranteed income) 
• Set up a drawdown scheme (this gives flexibility to the rest of your pot)
• Take out one or more taxable lump sums 
• A combination of one or more of the above

 

Buying an annuity

You have the option to exchange some or all of your pension pot for an annuity. A type of insurance product that pays you a guaranteed income for the rest of your life or for a set period.

The downside is that once set up, you cannot adjust the amount you receive, and it may take many years before you recoup the amount you paid for the annuity.

You can also choose an annuity that increases annually to help protect against inflation, although this option typically comes with a higher initial cost.

You can also opt for a joint annuity that includes your spouse, who continues to receive a reduced income after your death for the rest of their life. However, this type of annuity usually comes at a higher cost.

If you have a health condition, you may qualify for an enhanced annuity, which pays more but for a shorter period.

Setting up a drawdown scheme

You can use some or all of your pension pot to invest in a drawdown scheme. The primary advantage of a drawdown scheme is its flexibility, which allows you to take as much or as little as you would like each year. With the money being taxed as normal

A key downside of this option is that your pension pot will reduce over time, and you may run out of money. Another risk is that your money remains exposed to the stock market, which can cause it to fall in value as well as increase, thereby significantly reducing the time the money is available.

For example, if you take money out when the market is falling, it will be harder for the rest of your pot to recover. 

This is why you should consider saving some of your tax-free lump sum as emergency cover in case the stock market struggles.

This then allows you to reduce your drawdown income and reduce the impact on your pension pot. 

A taxable lump sum

After taking the 25% tax-free lump sum, you can withdraw the rest of your pension pot if you choose. However, the remaining 75% is taxed as regular income, which—especially for larger pots—can lead to a substantial tax bill and a significant reduction in your overall capital.

However, if you have a small pension pot that is separate from your main pension, taking the entire amount as a lump sum could be a practical solution. However, seeking professional advice from a financial advisor can be beneficial.

A combination of methods

You don't have to choose one option or the other, and if you wish, you can set up a range of different options for taking income from your pension pots, which will then provide both flexibility and security.

For example, you could set up a drawdown scheme to suit your needs in the initial stages of your retirement and then, as you age, use the balance of your pot to purchase an annuity.

As you are older, the annuity may offer a higher income. Another option would be to set up a small annuity to cover your basic needs and costs and then take extra income from the drawdown as needed.

Drawing a final salary pension

A final salary pension (also known as a defined benefit scheme) is a type of workplace pension that works differently.

This type of scheme doesn't accumulate a pot of money; instead, it provides a guaranteed income from a certain age. The level of income is usually calculated on your salary and length of service.

Some final salary schemes will allow you to take a tax-free lump. You don't have to do anything to draw this kind of pension, as it will be paid to you automatically from the date specified by the scheme. It is known as your 'normal retirement date' and is usually set around 60 (but this may be earlier or later).

Some final salary schemes will also allow you to transfer out of them. This is where you exchange your guaranteed pension benefits for a pension pot of a specific value. Although there can be advantages to doing this, there are also risks, and as such, you should speak to a financial advisor if you are considering this option.

Get expert advice

The pension choices you make should be based on your circumstances, goals, and aspirations. It's always a good idea to speak with a financial advisor who will help you make an informed decision. Additionally, your pension strategy may change during retirement due to changes in needs and economic considerations—a one. A monetary plan for your retiree will fit you and your circumstances.