According to the Institute for Fiscal Studies (IFS), more than four in ten people over 50 with a defined contribution pension pot are unclear on how they will access their pension savings.
In recent years more people are saving into defined contribution (DC) pension schemes rather than defined benefit (DB) schemes. This has been fuelled by the introduction of auto enrolment into workplace DC schemes, and the decline of traditional DB pensions.
But despite initiatives to educate pension scheme members about their options, an IFS press release reports that: “When asked how they plan to access their pension pots, more than four in ten of those in their 50s and early 60s with defined contribution pension pots answer ‘don’t know’.” This is described as ‘worrying’ by the IFS.
So, if you have saved into one or more DC pension schemes, what are your options for accessing your pension savings?
You are able to access your DC savings from age 55 (changing to age 57 on 6 April 2028) and have a number of options. Pensions can get quite complex, but below is a super-simple summary of your main options:
1. Leave all your money where it is
That’s right – the first option is to do nothing. If you don’t wish to take an income from your pension savings yet, that’s fine. You can simply leave the money in your existing pension scheme/s.
If you do this, the money will remain invested. That means the size of your pension savings could go up or down over time, depending on investment performance.
2. Take lump sums
You can typically take up to 25% of your pension savings as a tax-free lump sum. If you do, you can leave the rest invested where it is and take further taxable lump sums when you wish, or choose one of the options explained below.
3. Cash your pension in
After taking your 25% tax-free cash allowance, you can take the remainder as cash right away, taxable at your normal tax rate. This does run the risk that your income for the current tax year will take you into a higher tax bracket than normal.
4. Buy an annuity for guaranteed income
You can use your pension pot to buy an annuity from an insurance company. An annuity gives you a guaranteed income for either the rest of your life or a fixed term, unaffected by future stock market changes. You may welcome the option of guaranteed income; but remember that you will forfeit the opportunity to benefit from any future investment growth.
5. Choose drawdown for a flexible income
With this option, you choose a flexi-access drawdown provider and they invest your pension savings for you. You then take money from your savings as and when you wish, so it’s a flexible option. The value of your invested savings can go down as well as up, so your income isn’t guaranteed with drawdown.
6. Mix and match your retirement income options
You have lots of flexibility with your retirement income and can mix and match your options. For example, you may decide to take your 25% tax-free cash allowance, buy an annuity with some of what’s left to meet your essential monthly income needs, and put the rest into drawdown to top up your income as and when you wish.
How do I choose what’s right for me?
This is a simplified overview of your choices as an introduction to the subject of retirement income options. Please bear in mind that this article is for information only and is not a substitute for professional guidance or advice.
To help you understand your options further, a good starting point for UK pension savers is to use the government-backed Pension Wise service. This gives everyone over 50 the opportunity of free and impartial guidance on what to do with money in your defined contribution pension pots.
You may also decide to take professional pensions advice. There will typically be a cost for this. However, you may find that it more than pays for itself if it helps you make good decisions about your retirement income.
Don’t forget also that there are other ways to raise funds in retirement if your pension income is insufficient. Options such as downsizing, equity release or remortgaging may be worth considering if you are a homeowner. It may also be worth checking that you aren’t missing out on any state benefits that you are entitled to.
The above information does not constitute any form of advice or recommendation by London Loves Business and is not intended to be relied upon by users in making (or refraining from making) any finance decisions. Appropriate independent advice should be obtained before making any such decision. London Loves Business bears no responsibility for any gains or losses.
