Episode 7: What happens when you retire?

Transcript

At some point - perhaps, many years from now - it’ll be time to stop working and to enjoy your retirement. Now, that might feel like a long way off, but let’s talk about it - because the more you know ahead of time, the better prepared you’ll be to make the right decisions, and there are important decisions to be made.

So the first thing you’ll need to decide is when you’ll start taking money from your pension. Most people access their pension when they stop working in their late 60s, but you can actually start taking money out from your workplace or personal pension as early as 55 (or 57 from 2028). And that can be great if you want an early retirement, but it does potentially mean you’ll lose out on a decade’s worth of pension growth. Remember our friend, compounding returns? Well, those later years of your pension is when growth can really start to ramp up. So you’ll want to be absolutely sure that you’re willing to sacrifice that growth to access your pension early. Now, what you can do - and what’s become more common in recent years - is take some money from your pension in your late 50s, and then leave the rest invested until you fully retire in your 60s. That can be a nice way of getting some cash to renovate your home or send your kids to uni, for example, without drastically reducing your pension balance.

Whenever you retire, you’ll need to decide the best way of taking money out of your pension. You’ll have three main options...

First - and perhaps most commonly - you can choose to receive regular payments. This is called drawdown, and it can work well if you’re used to receiving a monthly salary, because you won’t have to change the way you budget your money. And it’ll be pretty easy to figure out how long your pension might last with the help of a pension calculator - take £1,000 a month out of a £100,000 pension, and it’ll keep you going for about eight years.* If you wanted it to last longer, you could take out less each month. That’s because however much you draw down, the rest of your pension will remain invested. But, it’s not an exact science, and the money you leave in your pension could grow or fall or stay the same. It really depends on how your investments perform.

Second, you can choose to take out money as and when you need it. So you could take out a few thousand pounds to buy a new car in January, and a few hundred for a holiday in July. This way, there’s the potential to leave more money invested in your pension where it has a chance to grow. Obviously, you’ll need to be careful with budgeting - or you might find yourself getting carried away and spending all your pension in a few short years. But, if you’re in a position where you don’t have to rely on your pension for day-to-day expenses, this could be a good option for you.

The third option is to use your pension to buy an annuity, which is a type of savings product that pays you a guaranteed monthly income for life, or a fixed number of years. Unlike pensions, lifetime annuities don’t run out after a certain time, which is one of the reasons some retirees find it an attractive option. But the downside is that they don’t offer the flexibility of a pension - you can’t take out a lump sum or change the amount it pays each month to suit your needs. And of course, there’s no chance of it growing like the money that might otherwise remain invested in your pension. Once you take out an annuity, and lock in a rate, there’s no going back.

Finally, there’s a secret fourth option. You can actually do a mix of all these things! So you could take out £10,000 when you turn 55, use half of your remaining pension to buy an annuity when you turn 65, and dip into the rest if and when you need to.

Now, all that applies if you have a defined contribution pension - which is most people. But if you’ve got the less-common defined benefit pension, things are slightly different - and it can be a little complicated, so we won’t go into the details here. But, generally, you’ll have the options of either taking out a lump sum when you turn 55 (or 57 from 2028), receiving regular monthly payments (usually for life), or transferring its ‘cash value’ to a defined contribution pension where you’ll have more options, like dipping into it whenever you need to. Some of these options could lose you valuable benefits, though. So it might be worth speaking with a qualified financial adviser first.

Another perk of pensions is that 25% of your withdrawals are tax-free. So you won’t have to pay tax on £25 out of every £100 you take out. And you can choose to take out money from the tax-free or taxable part of your pension with each withdrawal. For example, you could take out 25% of your pension completely tax-free when you turn 55 (or 57 from 2028), and then pay tax on all future withdrawals. Or you could access your pension as usual, and pay tax on 75% of each withdrawal.

No matter what type of pension you have, or how and when you decide to access it, most of the money you take out will count towards your income tax threshold. So if you take out £10,000 from the taxable portion of your pension in a year, and you also earn £20,000 from a part time job, you’ll be taxed as if you were on a £30,000 salary. Or if you were fully retired and took out £60,000 in a year, then you’d be taxed as if you were a higher rate tax payer. So you’ll need to be careful when considering taking out larger amounts, because you could end up paying a higher rate of tax than taking out smaller amounts over several years. The good news is that everyone gets a tax free Personal Allowance, which is currently £12,570 (less if your income is over £100,000). So you won’t be taxed on the first chunk of your annual income, no matter where it comes from.

So that’s most of what you need to know when it comes to taking money out of your pension. There are lots of things to think about. There are lots of decisions to make. But don’t worry too much if it sounds a little overwhelming, because pension providers are usually pretty good at presenting your options when you approach retirement age. And you can always get in touch with them to talk through it. You could also speak with a qualified financial adviser. Or alternatively, you can speak with the folks at Pension Wise, which is a government service that offers free, impartial guidance about defined contribution pensions.

Now one thing we haven’t talked about is the State Pension, which you’ll receive in addition to any workplace and personal pensions you already have. But it’s a pretty simple one to cover. Basically, so long as you’ve paid National Insurance for at least 10 years, you’ll receive a basic State Pension in monthly payments from the age of 66 - although this may be a little higher by the time you retire, because it gets raised every few years. If you’ve paid National Insurance for 35 years, you’ll receive the full State Pension, which is £203.85 per week (2023/24). Currently, you’ll receive a letter four months before you reach State Pension age with instructions on how to claim it. So, there’s not too much to worry about for now!

Okay, before we wrap up I just want to say that it’s never too early to plan ahead. The more prepared you are, the better decisions you’ll make. So think about the type of retirement you want. Do you want to retire early in your late 50s? Do you want to take out a huge lump sum? Do you want to receive £1,000 a month for 20 years? Whatever it is, start thinking about it now. PensionBee has some great resources and tools that you can use to plan your retirement income, including a pension calculator that can tell you how much you should be putting away now to build a pension that will meet your goals. You can find it on the website or, if you’re a PensionBee customer, their mobile app.

So, to summarise:

• You can usually access your pension from the age of 55 (rising to 57 from 2028), but taking money out that early will reduce its potential growth. That’s why many people take it in their late 60s.
• You’ll have a number of withdrawal options, from taking out money as and when you need it, to receiving a monthly income, to buying an annuity that can pay out a smaller but guaranteed monthly income for life (or a fixed number of years).
• 25% of your pension can be taken out tax-free, but the rest will contribute to your annual income tax threshold. So think carefully before taking out large amounts, which could push you into a higher income tax bracket.
• You’ll receive the State Pension when you turn 66, although this will be raised in future. And you’ll only receive the full State Pension amount if you’ve paid National Insurance for 35 years.
• And finally, don’t put off thinking about your retirement. The earlier you start planning, the more chance you’ll have of meeting your goals.

*Assuming standardised assumptions in line with long-term pension returns. Past performance is not a guarantee of future returns.

This video was presented by Patricia Bright on behalf of PensionBee. Patricia Bright isn't a financial adviser and the views and opinions expressed in this informative video are those of Patricia alone and do not constitute financial advice.

The content of this video has been reviewed by the pension experts at PensionBee and was confirmed to be correct and in line with current HMRC guidelines and legislation based on their understanding of current tax legislation as of 4 August 2023.

Remember, as with all investments, your capital is at risk.