Retirement today is very different to that of our parents’ or grandparents’ generations. We’re unlikely to have a retirement party on our 65th birthday. We’re equally unlikely to receive a guaranteed lifetime income from a Final Salary pension. Today, retirement is much more flexible for several social, economic and political reasons.
Arguably, the catalyst for change was Pension Freedoms; a big shake-up in retirement legislation that was introduced in 2015. You are now able to spend as much or as little of your pension, however you want, from age 55. In total, HMRC report a staggering £26.6 billion has been withdrawn since the reforms came into effect.
But, with greater flexibility in how you can access your pension comes greater complexity. With that in mind, let’s cover your retirement options. First of all, the five ways you can spend your Workplace and Personal Pensions:
1. Take a lump sum
The first thing people tend to think about withdrawing pension income is Tax-Free Cash. Also known as a Pension Commencement Lump Sum, you can usually withdraw anywhere up to 25% of the value of your pension free of tax from age 55. You don’t have to take all your Tax-Free Cash at once, and the remainder of your pension can stay invested.
2. Flexi-Access Drawdown
You can make multiple withdrawals, of any value, whenever you like after age 55. Beyond the typical 25% Tax-Free Cash, you are charged Income Tax on any other income. You need to be careful that the level of pension income you are taking doesn’t inadvertently push you into a higher Income Tax bracket. The 2019/20 rates and bands are;
- Personal Allowance – up to £12,500 – 0%
- Basic rate – £12,501 to £50,000 – 20%
- Higher rate – £50,001 to £150,000 – 40%
- Additional rate – over £150,000 – 45%
It’s also important to note that if you take income beyond your Tax-Free Cash you are restricted as to how much you can tax-efficiently pay back into your pension. This is called the Money Purchase Annual Allowance and it’s capped at just £4,000 a year.
Data from HMRC shows that flexible withdrawals hit an all-time high in the first quarter of this year, with 284,000 people making 648,000 withdrawals; the highest figures recorded to date. The value of those withdrawals exceeded £2 billion.
You are effectively able to treat your pension fund like a bank account, dipping in and out whenever you want. The danger is, however, spending too much too soon. It’s important to remember that pensions were designed to provide for later life, replacing income from your working career for the rest of your life.
3. Withdraw the whole thing
Again, from age 55, there’s nothing stopping you spending the entirety of your pension in one go! It’s unlikely we would ever recommend you ever do this, but the availability is there if your circumstances require it.
If you withdraw the whole thing, usually 25% of the value is tax-free and the balance is taxable as earned income. Such withdrawals are treated as a monthly income for tax purposes and therefore even small pension pots can be subject to significant tax. While it may be possible to apply to reclaim some tax, many people taking this option are not aware of the potentially significant tax that will be payable.
4. Purchase an Annuity
An Annuity used to be the default option for many retirees. It’s still a viable option today, especially for those requiring a guaranteed income for life or for those not wanting any risk.
Annuity rates are higher for older lives and may be enhanced for ill health or lifestyle factors.
It is possible to factor in guarantees and inflation proofing though these will reduce the starting income.
Annuities may not be suitable for early retirees or those requiring flexibility.
5. Leave it alone!
If you don’t need the income from your pension schemes you don’t have to make withdrawals. The main benefit of this, especially for high-net-worth families, is that pensions are typically exempt from Inheritance Tax.
If you pass away before age 75, a pension can be passed to beneficiaries tax-free and remain in a tax-efficient pension environment. If you die after age 75, your pension can be paid free of Inheritance Tax as a cash lump sum, but the beneficiary will pay Income Tax.
Alternative income sources
It’s not just pension schemes that can make up your retirement income. People are working longer in more flexible roles; income from employment might continue into your later years if you decide to do freelance work, for example. Other investments topping up your pension income can include;
- General Investment Accounts
- Offshore Bonds
- Property, either Buy to Let or via Equity Release
Making sure your income outlives you
Now you have greater control over the level of pension income you take, you need to take care that it lasts your lifetime. Apart from overenthusiastic spending, the main problem is that people tend to underestimate their longevity.
A recent report from the World Economic Forum (WEF) found that the average female in the UK will outlive her savings by 12.6 years, compared to the average man who will run out of savings 10.3 years prior to their death.
As Han Yik, Head of the Institutional Investors Industry at the WEF, explained: “The real risk people need to manage when investing in their future is the risk of outliving their retirement savings. As people are living longer, they must ensure they have enough retirement funds to last them through their longer lives. This requires investing with a long-term mindset earlier in life to increase total savings later on.”
Here to help
The retirement options most appropriate for you will depend entirely on your circumstances, goals and aspirations. You may find a hybrid approach of a mix of income sources suits you best. We are here to help you make sense of your retirement in the most tax-efficient, sustainable way possible. If you’d like to discuss your pensions and retirement plans with one of our financial planners, don’t hesitate to get in touch.