Taking your pension at retirement: as simple as it appears?
Thanks to the flexible pension options introduced in 2015 by then Pension Minister Steve Webb, obtaining the type of retirement you want has never been more achievable.
As I write this (things can change quickly when it comes to legislation), pension regulations allow individuals to access their benefits in their defined contribution schemes from age 55 onwards – that’s up to a whole decade earlier than they can draw their state pension.
Whether to access these, and how, are choices very much depending on the individual’s preferred route. If work is becoming less appealing, for example, you could either be slowing down or flat-out leaving your normal employment. For most, stopping work entirely is not the desire – they would just rather they weren’t committed to the old 9-5 every week. Your options
To help this, many defined contribution pensions allow members to take benefits on a phased basis, which means they can substitute the income reduction from working part time, i.e. working just three days a week yet maintaining the same standard of living as when working full time.
Another option available is to release the tax-free cash lump sum from the pension scheme while leaving the income in deferment. This has proved very popular, with individuals either supplementing reduced income from part-time working or as a means of clearing significant loans such as mortgages, thereby reducing the amount of income required to maintain living standards.
Most significantly, securing an income at retirement no longer means the retiree needs to purchase an annuity (a guaranteed income option). As a result, the selection of this type of arrangement has reduced in the last few years and it’s not hard to understand why – not only does the income usually stop on death, the level of income on offer itself has tended to be unattractive. Instead, the option many individuals now take is known as ‘drawdown’, where income is drawn from the fund while it continues in investment. However, this process requires ongoing management in a way an annuity does not.
It is even an option to take the entire pension fund as cash. With small pension pots, this has proved attractive, however, there are serious tax implications on the 75% of the fund not designated ‘tax-free cash’, so is an option that needs careful consideration before actioning.Take heed
Popularity and good decision making are not always the same and people need to understand that freedom to choose carries responsibilities. Worryingly, the Retirement Outcomes Review published by the Financial Conduct Authority highlighted that 28% of consumers taking drawdown were unaware of where their money is invested¹. Now, if your funds are not being appropriately invested, you could run out in mid-retirement!
So, while you should get excited about how flexible retirement options could assist you in slowing down at work or retiring prior to state pension age, you must be aware of the obvious (and more hidden) pitfalls. The best way for many of us to get on top of this will be to get financial advice before we get to retirement – helping us to properly plan and be in control of our future.
¹ FCA Retirement Outcomes Review final report June 2018