What are my pension pot options at retirement?

Before you retire, it’s a good idea to understand your pension options, as this will likely be the main source of your income during retirement. 

By now, you should have built up one or more workplace or personal pensions.

You can usually access from the age of 55, but this is increasing to 57 from 6 April 2028. 

It’s important to think carefully about your options, to ensure your pension lasts throughout your retirement.

Here are your main options for drawing your pension, along with the key issues to think about. 

This guide will focus on defined contribution pensions (defined benefit pensions work differently).

When can I take my pension?

If you have a defined contribution pension, then you can legally access the money from the age of 55 (rising to 57 in 2028). And, you don’t need to have retired.

However, it’s usually best to wait as long as possible before accessing it. That’s because your pension savings need to last the rest of your life.

If you’re making withdrawals and you’re still working, it’s important to be aware that your pension income is subject to tax, so you could face a hefty tax bill.

What if I decide to postpone my retirement?

You can leave your pension untouched until you need the money.

If you plan to wait, it’s worth checking if your pension provider is using ‘lifestyling’. This is an investment strategy where your pension funds are automatically switched into lower-risk investments (like bonds and cash) as your ‘retirement age’ approaches.

The idea is that this prevents your fund from large stock market drops right before you retire, but it will reduce the growth rate on your pot.

If this is a concern, it’s worth talking to a financial planner, who will be able to recommend appropriate pension investments.

While you can claim your state pension as soon as you reach state pension age, you can choose to  defer it in return for higher payments later on.

If you reach state pension age on or after 6 April 2016 and delay claiming, your state pension will rise by 1% for every nine weeks you defer or around 5.8% if you delay for a year.

As a rough guide, if a 66-year old deferred taking their pension for one year, they would need to live until age 82 (approximately) to break even and recoup the cash they missed out on during those 12 months.

Will my pension affect my benefits?

As some benefits are based on how much income you have, as well as savings and investments, you may become ineligible for some benefits if you access your pension.

It also depends on whether you are at least state pension age, as you may be able to claim pension credit.

If you can get pension credit, money from your pension you would be entitled to, and any funds you take out will be taken into account when working out your income.

But if you’re not claiming pension credit, only funds you withdraw from your pension are considered as income.

How to avoid pension scams

You’ve worked your whole life to build up your pension, so it’s vital you protect it from scammers.

There are many ways scammers try to get hold of your money, including offering fake investments with unrealistically high returns.

It’s worth being wary of any individual or business that approaches you for a free pension review,  a ‘once in a lifetime’ investment opportunity or access to your pension before age 55.

Scammers will try to rush you to make a decision, often claiming it’s a limited-time offer.

Scammers may also imitate genuine firms, which would never contact you without your permission.

Always check companies you are dealing with are regulated by the Financial Conduct Authority and take advantage of its free scam checker. 

It’s also sensible to chat through concerns with a financial planner.

What are your main pension options?

You have several options for accessing your pension. 

Each option has its own pros and cons, and some can be used in combination with others. 

• A 25% tax-free lump sum

• An annuity

• Drawdown

• Taxable lump sums 

Can you take a pension lump sum tax-free?

You can take up to 25% of any pension pot tax-free. Lots of retirees take the money in one go.

This can be an attractive option if you want a larger sum to spend early on in your retirement. You may want to treat yourself to a dream holiday or pay for home renovations.

But if you don’t need the money straightaway, it may make sense to leave it invested. If your pot continues to grow, this will increase the tax-free cash you  can eventually take.

You also don’t need to take the money in one go. You can take it gradually instead - this can be a helpful way of topping up your income, without increasing your tax bill.

However, you can only access your tax-free cash as a lump sum, when you go into drawdown or buy an annuity (more on those options below). This is referred to as ‘crystallising’ your pension.

A financial planner can help you work out what’s best for you.

How do I access the rest of my pension pot?

Once you have taken your tax-free lump sum, any further money you take from your pensions is taxable and will attract income tax, although you don’t have to pay national insurance on pension income.

You have a range of options for taking this income.

These are:

• Buy an annuity (a guaranteed income for life or a fixed period)

• Set up a drawdown scheme (to give you flexible access to the rest of your pot)

• Take out one or more taxable lump sums

• A combination of these options

We will now delve into each of these pension options in more detail.

How to buy an annuity

You can exchange some or all of your pension for an annuity. 

An annuity is a type of insurance policy, which will pay you a guaranteed income for the rest of your life.

The value for money you get will depend on how long you live. If you live for longer than anticipated you’ll get more back than you paid in, but if you die sooner, you might not recoup your investment.

Annuities can work well if you want peace of mind. However they aren’t very flexible and you can’t vary the amount you receive once set up.

You can, however,  arrange for your annuity to pay an increasing amount each year, to combat inflation, although this will pay less initially. 

You can also buy a joint annuity that covers your spouse as well, which will continue to pay out a reduced amount after your death, for as long as they live – but, again,  this will cost you more. 

If you have a health condition, you may qualify for a more valuable enhanced annuity. 

Find out more about the pros and cons of an annuity.

How to set up a drawdown scheme

Another way of generating income from your pension is to move some or all of your pot into a flexi access drawdown arrangement.

This allows you to leave your pension invested and make withdrawals direct from your pot.

The main advantage is flexibility, as you can draw out as much or as little as you wish each year, with the money being taxed as ordinary income.

The downside is that your income is not guaranteed and you need to manage withdrawals carefully, otherwise you could run out of money.

Your pot could also shrink when there is a stock market fall. 

And, if you take money out when the market is falling, it’s harder for the rest of your pot to recover later.

This is why it’s worth making sure you have access to other savings or sources of income that you can call on during extended periods of market volatility.

Stopping withdrawals from your pension will make it easier for your pot to recover.

A financial adviser can help you manage income drawdown if you like the idea, but are concerned about the responsibility of running it yourself. 

Find out more about the pros and cons of drawdown.

Uncrystallised fund pension lump sums

If you haven’t yet taken your tax-free lump, you have another option known as an uncrystallised funds pension lump sum (UFPLS).

This allows you to take a series of lump sums from your pension without moving your pension pot into a drawdown or buying an annuity. In these cases 25% of each withdrawal will be tax-free, and the remaining 75% will be taxed as pension income.

This option might be attractive if you haven’t yet decided how to access your pension. It can also add flexibility to your plans. However, you need to be aware that large withdrawals will carry a hefty tax bill.

If you have a small pension pot you don’t want to combine into your main pension, taking the whole thing as a lump sum may be a practical solution.

It’s worth talking to a financial adviser to see what they recommend.

A combination of methods

You don’t have to choose one option or the other exclusively. If you wish, you can set up various strategies for taking income from your pension pots to provide flexibility and security.

For example, you could set up a drawdown scheme to meet your needs in the first part of your retirement. When you are older and less active, you could use the remainder of your pot to buy an annuity.

As you’ll be older, you may be able to buy an annuity at a higher rate. Alternatively, you could set up a small annuity to cover your basic needs and take extra income from drawdown as necessary.

How does drawing a final salary pension work?

A final salary pension (also known as a defined benefit pension) is a type of workplace pension that works in a different way.

Instead of building up a pension pot, it pays you a guaranteed income from a certain age (a bit like an annuity).

Some final salary schemes will also enable you to take a tax-free lump sum as well.

You don’t have to do anything to draw this kind of pension, as it will be paid to you automatically from the date specified by the scheme.

This is called your ‘normal retirement date’ and is usually set around 60 (but may be earlier or later).

Some final salary pensions will allow you to transfer out of them, exchanging your guaranteed pension benefits for a pension pot of a certain value.

There can be advantages to doing this, but there are also significant risks, so you should speak to a financial adviser if you want to consider this option.

How does inheriting a pension work?

If you have a defined contribution pension, you may have unused pension wealth remaining to pass on to your loved ones.

There is currently no inheritance tax (IHT) to pay on inherited pensions, but the rules are changing. From April 2027, pensions will be subject to IHT and may be charged at 40%, depending on your other wealth and allowances available.

Pensions left to your spouse or civil partner won’t attract inheritance tax, as assets left to spouses are exempt from IHT. 

When it comes to withdrawing income from an inherited pension, the rules are different depending on your age when you die.

If you die before the age of 75, your beneficiaries can receive any remaining pension pot as a lump sum without paying income tax, but the amount is capped under the lump sum death benefit allowance (LSDBA).

If you pass away after age 75, the remaining pot will be taxed at your beneficiaries’ marginal rate.

These tax rules can be a crucial consideration in your retirement planning, as they impact how you might choose to manage your pension funds.

What should you do with your pension pot?

The pension choices you make should be based on your own personal circumstances and goals.

It’s a good idea to talk with a financial adviser, as they will help recommend the best course of action.

Your pension strategy may change during your retirement to reflect your adjusting needs and lifestyle. So, any advice can ensure your retirement is properly tailored to suit your needs.

If you are hoping to access your pension from the age of 55, see our article on retiring early.

You can estimate how much annual income to expect in retirement using Unbiased’s pension calculator below.

Get expert pension advice

Deciding what to do with your pension savings is one of the trickiest financial decisions you’ll make in your life  - weighing up considerations like flexibility, peace of mind and tax.

You’ll want to make the most of your new found freedom, but at the same time, need to ensure your money lasts as long as you need.

For this reason it makes sense to consult a financial planner. They’ll look at your overall financial position and, using detailed cashflow analysis, put in place a plan that works for you.  They’ll also ensure the plan is tax-effective, meaning you don’t pay any more than you need.

Let Unbiased quickly match you with a financial adviser for expert financial advice so you can make informed choices to help secure a comfortable and financially stable retirement.