Drawing an income from your pensions

First published 11 October 2017 • Updated 25 March 2019

After you’ve retired, your main source of income will most likely be from pensions. By now you should have built up one or more workplace or personal pensions, which you can access flexibly from the age of 55. How you do this will require careful planning, however, as this money needs to last you for the rest of your retirement.

N.B. This summary applies to defined contribution pensions only - a defined benefit (DB) pension works in a very different way.

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

Tax-free money up front

You have the option of taking up to a quarter (25 per cent) of your pension savings out as a lump sum, on which you pay no tax at all (this applies to all your pension pots). This can be an attractive option if you want larger sums to spend early on in your retirement, such as for travelling. However, you still need to keep a level head and ask yourself how much you can afford to spend. Of course, you don’t need to spend it at all – you could choose to reinvest some or all of it.

Taking the rest of your pension pot

Once you have taken your tax-free lump sum, any further money you take from your pensions is taxable as ordinary income. You have a range of options for taking this income. These are:

Read on for an overview of each option.

A guaranteed income for life

You can exchange some or all of your pension pot for an annuity. An annuity is a type of insurance product, which will pay you a fixed (or sometimes rising) income for the rest of your life. This income is guaranteed, so will never run out no matter how long you live. The downside is that you can’t vary the amount, and it could be many years before you get back as much as you paid for it. However, 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.

Flexible access to the rest of your pot

You can opt to have some or all of your pension pot reinvested in a drawdown scheme. The main advantage here 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 main downside is that your pension pot will shrink over time, and could eventually run out. Your money also remains exposed to the risks of the stock market.

Find out more about the pros and cons of drawdown.

A taxable lump sum

It’s possible to draw out the whole of your remaining pension pot (after taking the 25 per cent tax-free lump sum). However, this remaining 75 per cent will be taxable as ordinary income. For larger pots, this can result in losing a big chunk of your money in tax.

However, if you have a small pension pot that you don’t want to combine into your main pension, taking the whole thing as a lump sum may be a practical solution. Talk to your 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 a range of different strategies for taking income from your pension pots, to provide your ideal balance of flexibility and security.

Talk about your plans with your adviser, and they will help you put together the approach that suits you best. Your approach may even change over the course of your retirement, to reflect your adjusting needs and lifestyle. Advice can ensure that your retirement income strategy is always the right fit for you.

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About the author
Nick Green
Nick Green
Nick Green is a financial journalist writing for Unbiased.co.uk, the site that has helped over 10 million people find financial, business and legal advice. Nick has been writing professionally on money and business topics for over 15 years, and has previously written for leading accountancy firms PKF and BDO.