Just like in yoga, finding the right balance requires a little flexibility. When it’s time to start drawing an income from your pension, having options is essential. Fortunately, savers are now spoilt for choice. Pension legislation permits a flexible ‘pick and mix’ method for withdrawing funds from defined contribution pensions.
You don’t even have to stop working! Flexible retirement, or phased retirement, lets employees and the self-employed draw from their pension while continuing to work. This approach could enable you to:
- earn extra income alongside your regular salary;
- supplement your income while reducing your hours;
- continue contributing to your pension while you work; and
- defer your State Pension, increasing its payout for later.
Is flexible retirement a good idea? Keep reading to find out about your withdrawal options, tax implications of each and the questions you should ask yourself.
How can I take money from my pension?
The introduction of ‘pension freedoms’ reforms
In the past, if you retired with a defined contribution pension you usually had two options to take an income. You could use it to buy a pension annuity - a product that guarantees you an income for the rest of your life. Or, you could put it into ‘capped drawdown’ where the annual income amounts were capped at a set level.
Since the introduction of the ‘pension freedoms‘ in 2015, savers aged 55 and over (rising to 57 from 2028) have more choice on how to take an income from their defined contribution pension. More on this later!
As defined benefit pensions already provide an income based on your salary and length of service, the pension freedoms aren’t designed for savers in these schemes. In fact, if you have a defined benefit pension that’s worth over £30,000, you have to consult with an Independent Financial Adviser (IFA) before moving your pension.
This is because you need to understand the valuable special or safeguarded benefits you might be giving up, such as a protected retirement age.
Your withdrawal options under pension freedoms
If you have a defined contribution pension, you have several options for accessing your funds. Let’s explore the three main ways you can withdraw your money.
1. Flexi-access drawdown
Flexi-access drawdown is a pension that lets you access your pension savings whenever you need to, while continuing to invest your remaining funds in a way that’s specially designed to provide an ongoing retirement income.
This means you can take 25% of your pension as a tax-free cash lump sum, while the remaining 75% will be considered taxable income, which can be withdrawn whenever you choose. Additionally, you can designate funds into drawdown in phases, allowing for more flexible management of your retirement income.
2. Lifetime annuity
A pension annuity is a financial product that pays you a guaranteed income for a fixed period or for the rest of your life. When you retire, you can choose to use some or all of your pension savings to buy an annuity.
3. Lump sum payment
A lump sum payment is a withdrawal from your pension. The first 25% of your pension can be withdrawn tax-free, but you’ll need to pay tax on any further withdrawals. You could pay less tax if you apply the 25% tax-free amount to regular withdrawals throughout retirement, instead of taking it as a single tax-free lump sum.
What do I need to check before withdrawing?
Does my pension provider allow withdrawals?
Pension providers all have slightly different rules about accessing your pension, which could impact your flexible retirement options.
Check your pension policy to find out:
- the pension drawdown options they offer;
- the age you can start drawing down from your pension;
- whether you need to have paid into the pension for a qualifying number of years;
- if there’s a minimum or maximum amount you can withdraw while working; and
- whether there’s a limit to the number of times you can change your flexible working arrangements while withdrawing from your pension.
There can be significant penalties for breaking the terms of your pension arrangement. So it’s worth checking your options with your provider first.
Has my employer agreed to my reduced hours?
If your plan to flexibly retire is to reduce your hours at work and make up the difference with your retirement income, you’ll need to make sure your employer approves the arrangement. They may need to adjust their own plans to accommodate your new schedule.
If you work for a larger company, they’re likely more familiar with such requests. It’s a good idea to consult your firm’s flexible working policy and the HR team for advice before talking to your manager.
Remember, any employee has the right to make a statutory flexible working request from the first day of employment. If you work at a smaller company, consider discussing your plans with a trusted friend, family member, or colleague first to refine your approach and address any concerns.
Can I afford to flexibly retire?
When thinking about the kind of retirement lifestyle you’d like, you’ll need to make sure your pension pot is large enough to carry you through your twilight years. Retirement may be a lifestyle choice, but financing it is more of a maths equation.
It’s hard to predict how much you’ll need in your pension to enjoy a comfortable retirement since everyone’s circumstances are different. The average 65-year-old can expect to live for another 20 years, according to the latest government data, but many people live much longer.
In February 2024, the Pensions & Lifetime Savings Association (PLSA) released an update to their Retirement Living Standards. These standards illustrate what kind of lifestyle we can expect at retirement at three different income levels.
The report shows that single retirees would need:
- £14,400 a year for a minimum lifestyle;
- £31,300 a year for a moderate lifestyle; and
- £43,100 a year for a comfortable lifestyle.
While you might not have enough in your pension to fully retire from age 65, you may be tempted to draw down smaller amounts earlier to enjoy a flexible retirement. However, by choosing to flexibly withdraw at an earlier age, you may need to postpone the age at which you fully retire.
To give you an idea, a pension pot of £250,000 could last about 19 years if you withdrew £1,500 each month. But, you might choose to save or invest your income during your flexible retirement instead of spending it.
Keep in mind that inflation can erode the real value of your savings over time, and the investment returns on your pension may differ from those of non-pension investments. You could also continue contributing to your pension - but you’ll need to be careful of any tax implications. More on this later!
Tax implications of taking your pension
How much tax will I pay?
When you withdraw from your pension, 25% can be taken tax-free. However, the remaining amount will be taxed as income, which could push you into a higher tax bracket.
Example 1 (before adding pension income)
- you earn £30,000 from your job;
- your total earnings are £30,000;
- this classes you as a basic rate taxpayer; and
- you’d pay £3,486 in income tax.
Example 2 (after adding pension income)
- you earn £30,000 from your job;
- you draw down £30,000 from the taxable portion of your pension;
- your total earnings are £60,000;
- this classes you as a higher rate taxpayer; and
- you’d pay £11,432 in income tax.
Source: Figures calculated using the MoneySavingExpert Income Tax Calculator. Please note that the net tax you’ll pay depends on your personal tax code, which can differ from one person to another.
You might find it beneficial to withdraw a smaller amount now and save the rest for later when you’re fully retired. This way, you can manage your tax liability more effectively.
However, be cautious about taking a larger lump sum all at once, as this could result in more tax than you expect. Providers will apply an emergency tax rate to your first income withdrawal, which may lead to a higher tax deduction than anticipated.
Tax risks of contributing and withdrawing
Each tax year, you save up to a certain threshold (known as your ‘annual allowance‘) and receive tax relief on your contributions. For 2024/25, the annual allowance is 100% of your relevant UK earnings or £60,000 (whichever is lower). For the highest earners the annual allowance may be less depending on your adjusted income. This is known as the ‘tapered annual allowance‘.
If you exceed the limit, you’ll be eligible to pay tax on any amount over the contribution limit. This is called an ‘annual allowance charge’, and it would need to be reported on your Self Assessment tax return. It’ll be payable at your highest rate of income tax, and added to your overall tax liability due when tax is calculated.
Alternatively, you may be able to ask your pension provider to pay the charge from your pension benefits. This is known as Scheme Pays, and you’d need to discuss with your provider promptly as there can be strict deadlines. In some situations, you may be able to reduce the charge by bringing forward some of your annual allowance from previous years.
You can carry forward unused annual allowances from the three previous tax years, starting with the earliest tax year. You’ll need to have been a member of a pension for the previous tax years and your carry forward can’t exceed your gross earnings for the tax year in which the contributions over the annual allowance have been paid.
Why does this matter if I’m withdrawing money?
Another bit of legislation from the pension freedoms was the money purchase annual allowance (MPAA). Once you begin accessing the taxable portion of your defined contribution pension, your annual allowance is reduced to £10,000 (2024/25).
The MPAA is designed to help prevent ‘tax recycling’, where a saver could take their tax-free cash and put it back into their pension - receiving further tax relief.
Example: If you’re contributing £1k a month to your pension, then flexibly retire in May, you’ll need to reduce your monthly pension contributions for that tax year (and ongoing tax years) to ensure you don’t incur a tax charge.
You could reduce your risk of triggering the money purchase annual allowance by:
- only taking a tax-free cash payment from your pension; or
- taking income from a long-term annuity which doesn’t reduce.
Is it worth consolidating my pensions?
Consolidating your pensions can make managing your retirement savings simpler and more efficient. By combining your pots into one, you’ll:
- have a clearer view of your total savings, which can help with planning and decision-making;
- potentially save money if you’re paying multiple fees across different providers; and
- reduce paperwork and have fewer statements to manage.
How to consolidate your pensions
If you consolidate your pensions with PensionBee, you’ll gain access to withdrawal options like flexi-access drawdown and lump sum payments, giving you more control over how and when you withdraw your money. Or, you can generate a pension annuity quote in minutes online through our partner, Legal & General.
PensionBee also makes the process straightforward by handling the transfers for you, even if you don’t have all the details of your old pensions to hand. Plus, our online platform, the BeeHive, allows you to easily track and manage your savings in one place.
However, before consolidating, it’s important to check if any of your existing pensions come with valuable benefits or guarantees that you would lose by transferring. If you’re unsure, consider seeking advice from a qualified IFA.
Feeling unsure? Book a free Pension Wise appointment
Finally, if you’re still feeling uncertain about your retirement plans, consider booking a free appointment with Pension Wise, a service from MoneyHelper, once you turn 50. This government service is designed to help you understand your options as you approach retirement.
The best part? The appointment is completely free and impartial, giving you the chance to ask any questions you may have without any pressure. If you’re aged under 50, the MoneyHelper website provides a wealth of useful information related to pensions and broader financial matters.
Summary
Planning for retirement can feel overwhelming, but with the right information and a clear understanding of your options, you can make confident decisions about your future. Whether you’re considering flexible retirement, exploring your withdrawal options, or thinking about consolidating your pensions, it’s important to weigh the financial and tax implications carefully.
Remember, retirement isn’t just about numbers - it’s about creating the lifestyle you want while ensuring your pension can support you for the years ahead. If you’re unsure about your next steps, don’t hesitate to seek guidance. A free Pension Wise appointment or resources from MoneyHelper can provide valuable, impartial advice to help you navigate your retirement journey with ease.
Risk warning
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.
